Revenue and Customs v Frank A Smart & Son Ltd (Scotland) [2019] UKSC 39

A Scottish farming company purchased EU Single Farm Payment entitlements to fund its taxable business activities. HMRC refused to allow deduction of input VAT on the purchases. The Supreme Court dismissed HMRC's appeal, holding the VAT was deductible as business overheads.

Facts

Frank A Smart & Son Ltd (FASL) is a Scottish company carrying on a farming business at Tolmauds Farm in Aberdeenshire, wholly owned by Mr Frank Smart. FASL’s entire output was taxable under the VAT regime. Between 2007 and 2012, FASL spent approximately £7.7m purchasing 34,477 Single Farm Payment Entitlement (SFPE) units in addition to its initial allocation. To receive the Single Farm Payments (SFPs), FASL leased additional land under seasonal lets but did not cultivate or stock it. Between 2010 and 2013, FASL’s income from SFPs dwarfed its income from cattle sales. The First-tier Tribunal (FTT) found that FASL intended to use the SFP income to pay off its overdraft and fund business developments, including a proposed windfarm (on which over £119,000 was spent on preliminary investigations), additional farm buildings, and the acquisition of neighbouring farms.

FASL sought to deduct VAT of £1,054,852.28 as input tax on the SFPE purchases. HMRC refused. The FTT allowed FASL’s appeal, finding the acquisition was a funding exercise integrated with FASL’s farming enterprise. The Upper Tribunal and the Inner House of the Court of Session both dismissed HMRC’s appeals.

Issues

The central issue was whether a taxable person could deduct as input tax the VAT incurred in purchasing entitlements to an EU farm subsidy (the SFP), where the receipt of the subsidies was outside the scope of VAT but the funds resulting were to be used to fund current and future taxable business activities. This turned on the interpretation of articles 167 and 168(1) of the Principal VAT Directive (2006/112/EC) and the jurisprudence of the CJEU.

Arguments

HMRC’s Arguments

HMRC submitted that FASL acquired the SFPE units to generate SFP income, which was a form of investment income outside the scope of VAT. Relying on BLP Group plc v Customs and Excise Comrs, counsel argued that VAT paid on costs directly and immediately linked to an exempt supply could not be reclaimed even if the outcome was to produce funds used for downstream taxable activities, and that the same reasoning extended to transactions outside the scope of VAT. HMRC also argued the courts below erred in treating the VAT as deductible as a general overhead and in considering Mr Smart’s intention regarding use of the funds. HMRC invited a reference to the CJEU if there was any doubt.

FASL’s Arguments

FASL relied on the principle of neutrality, arguing that fully taxable traders are entitled to recover all input tax incurred in raising finance for their business, provided the finance is spent on the business making taxable supplies and the financing exercise itself remains outside the scope of VAT. FASL accepted that future use of the funds on non-VAT activities would restrict its entitlement to deduct.

Judgment

Lord Hodge (with whom Lord Reed, Lord Wilson, Lord Briggs and Lady Arden agreed) dismissed the appeal. The Court conducted a comprehensive review of CJEU jurisprudence including BLP, Midland Bank, Abbey National, Kretztechnik, Investrand, Securenta, SKF, Sveda, Iberdrola, and University of Cambridge.

The Court concluded that the CJEU’s case law establishes that there must be a direct and immediate link between input transactions and either (i) particular output transactions, or (ii) the taxable person’s economic activity as a whole where the costs form part of general overheads. Crucially, where professional services are acquired for an initial fund-raising transaction outside the scope of VAT, this does not prevent deduction of input VAT if the purpose of the fund-raising, objectively ascertained, was to fund economic activity and the funds are later used to develop the taxable business.

Lord Hodge held that there was no basis in CJEU jurisprudence for distinguishing expenditure on fund-raising by share sale from fund-raising involving receipt of subsidies over several years. The fact that subsidies were included in FASL’s profit and loss account did not distinguish the case from Kretztechnik and Securenta. The annual payment of subsidies was not a separate transaction from the acquisition of entitlements capable of breaking the link between the purchase and deployment of net proceeds in FASL’s subsequent economic activities. The FTT was entitled to conclude FASL was acting as a taxable person when it incurred the costs because it was acquiring assets to support its current and planned economic activities. No reference to the CJEU was necessary.

Implications

The decision confirms that a taxable person making only taxable supplies may deduct input VAT on fund-raising transactions that are outside the scope of VAT, provided the funds raised are intended to be used, and are used, to support the business’s taxable economic activities. The principle of neutrality underpins this outcome: the VAT system relieves the taxable person of the burden of VAT incurred in the course of all its economic activities.

The judgment provides a valuable summary of the CJEU jurisprudence on deductibility at paragraph 65. It makes clear that an existing business proposing to expand its economic activity stands in the same position as a start-up in relation to input VAT on acquisitions supporting future taxable supplies.

Lord Hodge recognised that the decision creates practical challenges for HMRC: taxable persons must provide objective evidence connecting fund-raising to proposed economic activities and maintain adequate banking arrangements and records. HMRC retains supervisory powers, including under regulation 3 of the Value Added Tax (Supply of Services) Order 1993, to charge VAT where funds are later diverted to non-business use. FASL accepted that any future non-economic use of the funds would trigger repayment obligations.

The decision is significant for businesses engaged in complex fund-raising models, confirming that the direct and immediate link test looks through fund-raising transactions outside the scope of VAT to the ultimate economic activity of the taxable person. It is particularly relevant for agricultural and other businesses relying on subsidies, and more generally for any taxable business raising finance through non-VAT transactions.

Verdict: Appeal dismissed. The Supreme Court held that FASL was entitled to deduct as input tax the VAT it had paid on the purchase of SFPE units, as the purchases constituted a fund-raising exercise with a direct and immediate link to FASL’s economic activity as a whole, forming part of its general overheads.

Source: Revenue and Customs v Frank A Smart & Son Ltd (Scotland) [2019] UKSC 39