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Cause and effect in partial exemption

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A recent example is the FTT decision in British Credit Trust Ltd [2014] UKFTT 0744 (TC) (TC03863). This partly related to costs of repossessing hire-purchased vehicles from defaulting customers. The taxpayer argued that these costs solely related to taxable supplies. HMRC said they were overheads of a partly exempt business, the exempt component being the HP finance.

An eye-catching aspect was the taxpayer’s argument that there was a separate supply of services of ‘helping the customer fulfil his contractual obligation to return the car’ if he defaulted, for which the customer paid by bearing that cost. The argument was that repossession costs were directly link to this ostensible service of assisting the customer. HMRC described the notion as ‘absurd’, and the tribunal rejected it as being an illusion.

This left the taxpayer with two arguments: that these were a necessary cost of the original taxable sale of the car, but that they had no direct and immediate link with the exempt finance supplies; or that the costs were wholly related to the resale of the car (a taxable supply) and this negated any link with the original contract.

The tribunal dismissed the first of the remaining arguments with no particular analysis. It simply adopted HMRC’s view that the costs of repossession would have, in that case, to relate to all of the original supplies – taxable and exempt, not merely to the taxable component.

But it latched on to the third argument. This was that the costs had such an emphatic link to the resale of the vehicle (post-repossession) and this ‘trumped’ any link to the original transactions. The tribunal held that the costs were attributable solely to taxable supplies of the resold car.

This leaves me wondering. What about the ‘but for’ argument? I can see that, as a matter of process, the cars had to be repossessed and delivered to the auction house in order to be resold. At first glance, this appears to create a direct use of those costs which is unimpeachable. But could it be argued that, were it not for the repossession activity, the business would not be able to resell the cars? And is that the only connection? In other words, is it merely circumstantial that the repossession costs arising from the customer’s default was a necessary precursor to reselling the returned car? Can one attribute a purchase engendered by the original contract to a later sale, which might or might not occur depending on other circumstances, under a different contract, in respect of which the repossession activity was perhaps coincidental? Was it because, in cases where the taxpayer had no intention to resell the car (it being commercially unviable), it would not repossess, and thus would avoid the cost?

That may have been a clinching argument, but it would have been helpful if the whole ‘but for’ issue had been discussed.

What about the lightly dismissed argument that the costs necessarily relate to the very first supply? After all, the costs arise as a preordained part of the process in the event of the customer’s failure to fulfil his obligations. The cost of rectifying that is an occasionally necessary cost arising from the contract. In that case, what about HMRC’s argument that it must relate to both original transactions under that contract – exempt as well as taxable? Well, as there are two supplies, one has to find a separate direct and immediate link between the repossession and the grant of finance. Such a link might also be circumstantial. After all, transactions could be devised where no exempt finance arises, but a seller nonetheless needs to repossess. Perhaps the repossession cost can only relate to the goods being repossessed. Is that the answer? Does it not matter whether the taxable supply to which the costs relate was the original sale or resale?

Perhaps what is critical is that the actions taken to take physical goods can only have a direct link to the taxable supplies of those goods, and that any link with finance falls under the self-same ‘but for’ objection.

That said, an appeal seems likely.