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The Court of Appeal has dismissed an appeal by a casino operator seeking to recover additional input VAT by apportioning overhead costs using floor space rather than turnover. The Court confirmed that the company had failed to demonstrate that its proposed method produced a fairer or more reasonable result than the standard VAT apportionment method.
The decision provides important guidance for businesses making both taxable and exempt supplies, particularly in the leisure, hospitality and gaming sectors.
Background to the Dispute
The casino operator made a mixture of supplies, including:
- exempt gambling services; and
- taxable supplies from bars, restaurants and a theatre within the casino.
It incurred significant overhead costs, such as rent, marketing and security, which could not be directly attributed to either taxable or exempt activities. Under VAT law, such “residual input VAT” is normally recovered using the standard turnover-based method.
The company argued that this approach did not produce a fair and reasonable result. It therefore sought a standard method override under Regulation 107B of the Value Added Tax Regulations 1995, proposing instead to apportion VAT by reference to floor space allocated to taxable and exempt activities.
The difference between the two methods amounted to almost £3.3 million in VAT over six tax years.
HMRC Refusal and Tribunal Proceedings
HM Revenue & Customs (HMRC) refused to approve the floor space method. Following two unsuccessful internal reviews, the company appealed to the First-tier Tribunal (FTT).
The FTT allowed the appeal, finding that the floor space method provided a fairer, more reasonable and more precise proxy for the economic use of the company’s overhead expenditure than the standard method.
HMRC appealed to the Upper Tribunal (UT), which overturned the FTT’s decision.
Upper Tribunal: Failure to Address Dual Use
The UT found that the FTT had made a material error of law by failing to address HMRC’s argument that the bars, restaurants and theatre were not used exclusively for taxable supplies.
HMRC contended that these areas were also used to support the casino’s gambling activities, meaning there was dual use of the space. The floor space method, however, treated those areas as wholly taxable, which did not reflect the economic reality.
Remaking the decision, the UT concluded that the company had not shown that the floor space method provided a more precise measure of use than the standard turnover-based method.
Court of Appeal Upholds HMRC’s Position
The company appealed to the Court of Appeal, arguing that the FTT had in fact considered the dual-use issue and that the UT had adopted the wrong approach when remaking the decision.
The Court rejected both arguments. It found that:
- the FTT’s judgment contained no analysis of HMRC’s dual-use case;
- the UT was therefore correct to set aside the FTT’s decision; and
- the UT had applied the correct legal test when remaking the decision.
The Court confirmed that the starting point was the company’s proposed floor space method, and the question was whether that method produced a more precise result than the standard method. The company had failed to displace the standard method.
The appeal was dismissed.
Q&A: Input VAT Apportionment Explained
What is residual input VAT?
Residual input VAT is VAT on costs that cannot be directly attributed to either taxable or exempt supplies and must therefore be apportioned.
What is the standard VAT apportionment method?
The standard method typically allocates residual input VAT based on the proportion of taxable to exempt turnover.
When can a business use a different method?
A business may apply for a standard method override if it can demonstrate that an alternative method produces a fairer and more reasonable result.
Why did the floor space method fail in this case?
Because it did not properly reflect the dual use of hospitality and entertainment areas, which supported both taxable and exempt gambling activities.
What does this mean for businesses with mixed supplies?
It reinforces the high evidential threshold required to displace the standard method and the importance of demonstrating that any alternative method more accurately reflects economic reality.