Aspire in the Community Services Limited v The Commissioners for HMRC

Introduction

1. The Appellant (ACSL) is appealing against the decision issued by the Respondents (HMRC) on 29 March 2022, which was subsequently varied on 19 August 2024 and 19 September 2025, (the Decision) to refuse repayment of part of the input tax claimed by ACSL for the 07/21 VAT period.

2. This appeal concerns the recoverability of VAT paid on pre- and post-registration purchases where the taxpayer was making wholly exempt supplies pre-registration and then a mixture of exempt and taxable supplies post-registration.

3. The amount now in dispute is £22,487.12.

4. There are at least seven other appeals by businesses in the care sector which raise similar issues relating to pre-registration VAT that have been stayed behind this appeal. Background and Facts

5. The documents to which we were referred are included in two electronic bundles made up of 988 pages in total and a supplementary bundle of 173 pages. We also had the benefit of each party’s written skeleton argument. The bundles included two witness statements with exhibits for ACSL. One witness statement was from Mr John O’Hare who is an Indirect Tax Manager in the VAT team of VAT Solutions, ACSL’s VAT advisors. HMRC accepted Mr O’Hare’s evidence on the relevant factual background and the methodology ACSL used to calculate its recoverable input tax for the Period. The Tribunal therefore adopted Mr O’Hare’s written witness statement and he was not cross examined by HMRC. The other witness statement was from Dr Kay Linnell OBE who is a forensic accountant and provided expert accounting evidence on the economic life of capital assets and their residual value. Dr Linnell gave oral evidence at the hearing and was cross-examined by Ms Brown and answered questions from the panel.

6. From all of the above we set out below the relevant background to this appeal and make the following findings of relevant facts.

7. From 2009, Aspire in the Community Ltd (ACL) provided welfare services to clients, which include local authorities and clinical commissioning groups. ACL was registered with the Care Quality Commission (CQC) and consequently supplied exempt welfare services under Item 9, Group 7, Schedule 9 to the Value Added Taxes Act 1994 .

8. ACSL was incorporated on 11 January 2011. Some years later it was decided that ACSL would become the supplier to local authorities and clinical commissioning groups. This entailed ACSL becoming a party to new, or novated contracts with such customers.

9. HMRC received an application for VAT group registration on 12 February 2021, as a result of which ACSL and ACL are members of a VAT group (the VAT Group) of which ACSL is the representative member.

10. ACSL is not registered with the CQC and so any supplies of welfare services that it makes are standard rated for VAT purposes. ACSL was registered for VAT with effect from 1 May 2021, which is the effective date of registration (EDR).

11. Prior to the EDR, ACSL made no supplies and ACL made only exempt supplies.

12. The disputed deductible input tax was incurred both before and after the EDR and was claimed for the 07/21 VAT period (the Period).

13. ACSL’s first taxable supplies were made in November 2021, in the VAT period 01/22.

14. As a result of ACSL making taxable supplies from VAT period 01/22 onwards and ACL continuing to make exempt supplies, the VAT Group is partially exempt.

15. ACSL’s VAT return for the Period included a claim for an input tax credit of £31,727.29. Mr O’Hare explained in his written witness statement how this claim was calculated as follows: “12. The first VAT return was for the period ending 31 July 2021 and input tax relating to both pre-registration and post-registration purchases was declared on this return.

13. Input tax of £33,538.42 was included in relation to pre-registration purchases. This was calculated by detailed examination of the purchase ledger comprising of 12,511 individual transactions. a) All purchases with a transaction date more than 4 years prior to the date of registration were identified and excluded from the calculation. b) Checks were made on the suppliers of the remaining purchases and any that could not be identified as being VAT registered were excluded from the calculation. c) The remaining purchases were separated into those relating to goods and those relating to services. d) All services with a purchase date more than 6 months prior to the date of registration were identified and excluded from the calculation. e) Any goods which were not still on hand at the date of registration were identified and excluded from the calculation. f) Having thus identified the potential input tax recovery, copies of invoices were obtained, and the actual VAT value of those purchases established. The final pre-registration claim consisted of 113 individual transactions.

14. Input tax of £8,208.01 was included in relation to post-registration purchases. This was established by reference to electronic records which had been maintained from the effective date of registration. The entries on these reports were verified by reference to a sample of purchase invoices.

15. Any purchases relating to projects which would qualify for the capital goods scheme were identified and removed from the input tax to be claimed.

16. As both taxable and exempt supplies were intended to be made a partial exemption calculation was carried out using the use-based method detailed in reg 101(2)(e) which enables the attribution of input tax on the basis of the extent to which the purchases are to be used in the making of taxable supplies.

17. The use-based recovery rate was calculated by comparing the funding received from public bodies who VAT Solutions previous experience had demonstrated would novate contracts to the contract management company within a reasonable timescale to the total value of funding received.

18. Whilst Aspire does not receive any private funding, and such funding does not feature heavily in the specific sector in which they operate, an allowance of 1% was applied to the recovery rate to represent the possibility of such funding in the future.

19. These calculations produced a recovery rate of 76%. This was applied to the total input tax of £41,746.63 and resulted in recoverable input tax of £31,727.29 which was declared on the return.” HMRC Decision dated 29 March 2022

16. On 22 September 2021 HMRC opened an enquiry into ACSL’s VAT return for the Period and issued its decision in relation to that enquiry on 29 March 2022 reducing the deductible input tax from £31,727.29 to £7,138.

17. The 29 March 2022 decision was based on the following methodology which had been set out by HMRC in an earlier letter of 21 March 2022 (the 21 March 2022 Letter): Pre-EDR VAT on goods

18. In relation to VAT incurred by ACSL on goods prior to the EDR which were still on hand at the EDR, HMRC calculated the deductible input tax in two stages. First they calculated the depreciated value of those goods at EDR based on 5 years useful economic life, then they allowed input tax recovery of the VAT incurred on that depreciated value at a recovery rate based on the projected taxable supplies as a proportion of total supplies over the four years after the EDR.

19. This two stage calculation resulted in an input tax recovery rate of 0% in the first year post EDR, 84% in the second and third year post EDR and 100% in the fourth year post EDR. The amount of input tax on which the recovery rate was based in each year was also different as it was dependant on how much of the economic life remained for the goods purchased pre EDR in each year. So for example 20% of the VAT incurred on goods that were purchased 4 years before EDR would be brought into the calculation for only the first post EDR year, when the recovery rate was 0%. Goods purchased a year before the EDR would still have 4 years economic life remaining so 80% of the VAT incurred on their purchase was divided by four and then the rate for each year was applied to each quarter and added together.

20. In the 29 March 2022 decision letter HMRC explained the basis of the pre-EDR VAT decision as follows: “There is no statutory entitlement to allow recovery of VAT on pre-registration costs where those costs were first used to make wholly exempt supplies. However, Regulation 111 allows HMRC to exercise its discretion where it is reasonable to do so and to permit pre-registration VAT to be treated as input tax.”

21. The approach HMRC took in calculating how much of the pre-EDR VAT is deductible input tax is summarised in the 21 March 2022 Letter as follows: “this approach takes into account both the extent to which assets have been partially used prior to registration in making wholly exempt supplies and partly taxable use to which they will be put after registration.”

22. Ms Brown explained in her skeleton argument how the rate calculated by HMRC differed depending upon how much of the useful economic life remained at EDR as follows: “i. Goods with 1 year of their economic life remaining: 0% applied as no taxable supplies were made in year 1 of registration. ii. Goods with 2 years of their economic life remaining: 0% applied to half of the VAT treated as input tax and 84% to the other half as the recovery rate in year 2 was 84% (an effective recovery rate of 42%). iii. Goods with 3 years of their economic life remaining: 0% applied to one third of the VAT treated as input tax, 84% to one third and 100% to the other third as the recovery rate in year 3 was 100% (an effective recovery rate of 61.333%). iv. Goods with 4 years of their economic life remaining: 0% applied to one quarter of the VAT treated as input tax, 84% to one quarter and 100% to the other two quarters as the recovery rate in years 3 and 4 was 100% (an effective recovery rate of 71%). • HMRC’s method takes into account both the extent to which goods were used to make wholly exempt supplies prior to registration and the partly taxable use they are forecast to be put to after registration.” Pre-EDR VAT on services

23. HMRC refused any input tax recovery for VAT incurred on services prior to the EDR on the basis that those services had been fully consumed prior to ACSL making any taxable supplies. Post-EDR input tax on goods

24. In relation to input tax incurred by ACSL on goods after the EDR, HMRC applied an agreed recovery rate of 77%, based on projected use for taxable supplies. Post-EDR input tax on services

25. Input tax incurred by ACSL post EDR on services was disallowed on the basis that these “revenue costs” had been “used and consumed” in making wholly exempt supplies between the EDR and November 2021 when it made its first taxable supply. HMRC Decision dated 19 August 2024 Pre-EDR VAT on services

26. On 19 August 2024, HMRC amended the Decision in relation to the pre-EDR VAT incurred on services on the following basis: “the services listed at Appendix 3 relate (at least in part) to the making of supplies after your EDR. I have therefore decided that some additional VAT recovery may be permitted on these services under Regulation 111 of The Value Added Tax Regulation 1995 and sections 25 and 26 of the Value Added Tax Act 1994 to the extent that the services are used to make taxable supplies after your EDR.”

27. HMRC therefore accepted that some services purchased within 6 months prior to the EDR had not been wholly consumed prior to the EDR and they calculated the deductible input tax of the unconsumed services at EDR based on them having an economic life of 5 years and then applied the same recovery rate as for goods.

28. As a result of this amendment to HMRC’s calculation, the amount of deductible input tax was increased by £2,102.17 to £9,240.17. HMRC Decision dated 19 September 2025 Pre-EDR VAT on services

29. HMRC further varied the decision on the basis that it accepted that some of the applicable services had an economic life of 10 years.

30. The effect of this further variation is that the deductible input tax was further increased by £333.29 to £9,573.46. The Issues

31. In ACSL’s VAT return for the Period it claimed a repayment of input tax in the amount of £31,727.29. The Decision, as varied on 19 August 2024 and 19 September 2025, allows repayment of only £9,573.46 of that input tax. This appeal therefore concerns the remaining £22,153.83 of input tax that HMRC has disallowed.

32. ACSL state in their skeleton argument that the issues for determination by the FTT are as follows: “ Pre-registration VAT (Ground of Appeal 2) a. When calculating the proportion of allowable input tax by reference to the use, or intended use, of pre-registration purchases, whether some of the input tax should be allocated to the period prior to the EDR (as contended by HMRC) or if any pre-EDR use is to be disregarded (as contended by ACSL) b. If the use of goods prior to the EDR must be taken into account, whether HMRC’s or ACSL’s methodology for doing so is preferable. In particular: i. Whether all assets should be treated as having a useful economic life of 5 years (as contended by HMRC) or if instead the assets have different lifespans depending on the type of asset (as contended by ACSL); and ii. Whether usage is affected by the increasing in turnover of the business (as contended by ACSL) or not (as assumed by HMRC’s methodology) c. In light of the above, whether HMRC’s revised approach to services also requires amendment; Post-registration VAT d. Whether it is appropriate to draw a distinction between “capital” and “revenue” expenses in order to differentiate between items which relate to taxable supplies (as decided by HMRC) or not (as contended by ACSL).”

33. HMRC state in their skeleton argument that the issues for determination by the FTT are as follows: “i. The Pre-Registration Recoverability Issue: a) Whether pre-EDR use is relevant; b) If so, whether the goods should be treated as having a useful economic life of 5 years based upon depreciation or whether their economic lifespan should differ depending on the type of asset; c) How turnover may be used as a proxy for use. ii. The Post-Registration Recoverability Issue a) Whether, on the facts of this case, recovery should be restricted to capital items with an enduring lifespan that will be used in future periods.” Legislation

34. We summarise below the main legislative provisions that this appeal is concerned with. Unless otherwise stated, references to sections in this decision are to the Value Added Tax Act 1994 ( VATA 1994 ) and references to regulations are to the Value Added Tax Regulations 1995 (SI 1995/2518).

35. Section 25(2) provides that a taxable person is “entitled at the end of each prescribed accounting period to credit for so much of his input tax as is allowable under section 26”.

36. Before we consider the detail of input tax that is allowable under section 26, it is clear from section 25(2) that only a ‘taxable person’ is entitled to claim a credit for his input tax. Prior to the EDR, ACSL was not a taxable person and is therefore not entitled under sections 25 and 26 to credit for any of the VAT it incurred prior to the EDR.

37. Section 24(6)(b) provides a power for regulations to be made that allow a taxable person to “count as its input tax” certain pre-registration VAT it has incurred. The power in section 24(6)(b) as far as relevant to this appeal reads as follows: “(6) Regulations may provide – … (b) for a taxable person to count as his input tax, in such circumstances, to such extent and subject to such conditions as may be prescribed, VAT on the supply to him of goods or services … notwithstanding that he was not a taxable person at the time of the supply or payment.”

38. Regulation 111 was made using the power in section 24(6)(b). Regulation 111 is entitled “Exceptional Claims for VAT Relief” and sets out the circumstances in which HMRC “may authorise a taxable person to treat” VAT paid on pre-registration purchases “as if it were input tax”. This discretion is subject to some conditions that are set out in regulation 111(2). For example HMRC may not authorise a taxable person to treat as input tax, VAT incurred on pre-registration purchases in the following circumstances: 1) The goods or services on which the VAT was incurred have already been supplied or consumed before registration; 2) The VAT was incurred on goods more than 4 years before registration; or 3) The VAT was incurred on services received more than 6 months before registration.

39. Regulation 111 also stipulates that the taxable person must normally make a claim for pre-registration VAT to be treated as input tax in the first return that the taxable person is required to make and that the claim must be supported by invoices and other evidence.

40. Returning then to consider what input tax is allowable as a credit, section 26 provides as follows: “(1) The amount of input tax for which a taxable person is entitled to credit at the end of any period shall be so much of the input tax for the period … as is allowable by or under regulations as being attributable to supplies within subsection (2) below. (2) The supplies within this subsection are the following supplies made or to be made by the taxable person in the course or furtherance of his business – taxable supplies; …. (3) The Commissioners shall make regulations for securing a fair and reasonable attribution of input tax to supplies within subsection (2) above,….”

41. Regulation 101 was made using the power in section 26(3) and sets out the rules for attribution of input tax to taxable supplies. A taxable person is entitled to credit for the whole of the input tax incurred on goods or services that are used or to be used by him exclusively in making taxable supplies (regulation 101(2)(b)). A taxable person is not entitled to credit for any input tax incurred on goods or services that are used or to be used by him exclusively on making exempt supplies (regulation 101(2)(c)).

42. Where, as in this appeal, the taxable person has incurred input tax on goods or services which are used or to be used by him in making both taxable and exempt supplies such input tax is referred to as “residual input tax” in regulation 101 and we use the same term in this decision.

43. Where a taxable person has residual input tax, regulation 101(2)(d) and (e) set out how the deductible input tax is calculated as a proportion of the residual input tax .

44. Regulation 101(2)(d) provides for the calculation of the residual input tax that is deductible based on the proportion of total supplies that are taxable supplies in the period as follows (the standard-method): “there shall be attributed to taxable supplies such proportion of the residual input tax as bears the same ratio to the total of such input tax as the value of taxable supplies made by him bears to the value of all supplies made by him in the period”

45. Regulation 101(2)(e) allows for an alternative method of calculation to the standard-method, based on the actual or intended use of the goods or services for making taxable supplies as a proportion of total supplies as follows (the use-based method): “the attribution required by subsection (d) above may be made on the basis of the extent to which the goods or services are used or to be used by him in making taxable supplies” Pre-Registration VAT

46. We will first consider the pre-registration VAT issues. As stated above ACSL is not entitled to a credit for pre-registration VAT pursuant to section 25(2) . ACSL is only entitled to treat pre-registration VAT as input tax and therefore claim it as a credit against output tax (subject to the rules in section 26) if HMRC exercises its discretion under regulation 111 to allow it to.

47. Mr O’Hare stated in his witness statement that ACSL did not include in its claim for the Period any pre-Registration VAT paid on goods that HMRC did not have a discretion to authorise ACSL to treat as if it were input tax pursuant to regulation 111(2) and HMRC do not dispute this. The Disclosure Decision

48. HMRC’s original statement of case in this appeal stated that the issues before the Tribunal were as follows: “33. The Tribunal is asked to decide: 1) Whether the Respondents have correctly applied Regulation 111 in exercising their discretion and permitting partial recovery of pre-registration VAT incurred in relation to wholly exempt supplies; 2) In exercising this discretion, whether the Respondents have reasonably apportioned and quantified the recoverable VAT …”.

49. The Appellant subsequently applied to the Tribunal for an order that HMRC disclose information about the identity of HMRC’s decision makers and contemporaneous evidence of HMRC’s reasons for the decision. Judge Scott stated in her decision on that application ( Aspire in the Community Services Ltd v HMRC [2024] UKFTT 176 (TC) (the Disclosure Decision) at [73]: “The information sought is broadly that which would be sought in judicial review proceedings concerning the exercise of an administrative discretion. It is common ground that bringing an appeal is the appropriate route to challenge the decision in this case, rather than judicial review.”

50. At the hearing of the disclosure application, HMRC’s position was that there were two stages in the decision which Judge Scott set out in her decision at [100] as follows: “(a) there was a decision to allow tax to be treated as input tax in terms of regulation 111, and (b) a decision as to the amount of tax in terms of section 26 VATA which deals with “Input tax allowable under section 25 ”.”

51. In other words HMRC submitted that it had limited the recovery of the Pre-Registration Input Tax (see paragraph [55] below), not because of the exercise of its discretion under regulation 111 but because of the “normal rules of deduction” set out in VATA 1994 .

52. Judge Scott agreed with HMRC’s submission stating at [124](b) of her decision: “…there were two stages in the decision, namely a “prior” or “gateway” decision in terms of Regulation 111 to treat pre-registration tax as input tax and a subsequent decision based on section 26(1) and (2) VATA to quantify the allowable input tax.”

53. Judge Scott goes on to clarify as follows: “[127] I accept the argument that whether one describes it as a first stage in a decision or as a prior decision, there was a decision to allow expenditure to be treated as input tax. That decision was made in exercise of HMRC’s discretion and in that regard the Tribunal has a supervisory jurisdiction. [128] I find that, having made that decision, as it were in principle, then as Judge Bishopp pointed out in Wilf Gilbert , the provisions of VATA must be applied and the officer did so. That is the second stage or the second decision. Ms Brown is correct to say that those provisions are not discretionary. The Tribunal’s jurisdiction in that regard is therefore not supervisory.”

54. Neither HMRC nor ACSL appealed against the Disclosure Decision.

55. The position is therefore that HMRC exercised its discretion under regulation 111 to allow ACSL to treat all of the pre-registration VAT it claimed in its return for the Period to be “treated as input tax” (the Pre-Registration Input Tax). The exercise of HMRC’s discretion under regulation 111 was therefore entirely in ACSL’s favour and accordingly ACSL is not appealing against the exercise of that discretion.

56. The issue with respect to the Pre-Registration Input Tax for this tribunal to decide is therefore solely in relation to the second stage of the decision or the second decision that HMRC made, to determine how much of the Pre-Registration Input Tax is deductible in the Period, based on the statutory rules for deduction of input tax, which is governed by sections 25 and 26 and regulation 101. Submissions, Discussion and our View

57. We were very much assisted by the submissions both written and oral by Michael Ripley for ACSL and Charlotte Brown for HMRC. However, although we have considered all of the submissions, we have not found it necessary to refer to each and every argument advanced or all of the authorities cited in reaching our conclusions.

58. We start by setting out the following preliminary points: 1) not all input tax is deductible; 2) ACSL intended to make both exempt and taxable supplies after the EDR and was therefore partially exempt for VAT purposes and the Pre-Registration Input Tax is residual input tax; 3) regulation 111 provides no mechanism to determine how much of the Pre-Registration Input Tax is allowed as a credit; 4) the normal statutory rules governing apportionment of residual input tax ( sections 25 , 26 and regulation 101) apply to determine how much of the Pre-Registration Input Tax is allowed as a credit against output tax; 5) HMRC have agreed that ACSL can use the use-based method (regulation 101(2)(e)) to calculate the proportion of Pre-Registration Input Tax that is allowed as a credit.

59. Where the parties disagree is how the use-based method applies to the Pre-Registration Input Tax. HMRC submit that it is necessary to first take into account the pre-EDR exempt use of the relevant goods and services, whereas ACSL submit that it is only permissible to consider the current or future use of those goods and services.

60. In summary Mr Ripley submits for ACSL: 1) The limitations in regulation 111(2) on what pre-registration VAT can be treated as input tax are themselves designed to address pre-registration usage and to remove the need for detailed calculations of the use before and after the EDR. 2) The allowable credit is subject to the apportionment rules in regulation 101 but subject to that, VAT paid on goods that were purchased within four years can be recovered in full and there is no need for complicated calculations that take pre-registration usage into account. 3) The Pre-Registration Input Tax is subject to the ordinary principles of partial exemption and apportionment, such as the use-based method in regulation 101(2)(e), but that is based on how the goods or services “are used” (in the current period) or “are intended to be used” (in the future). Regulation 101(2)(e) is not concerned with how goods were used in previous periods. 4) The same is true for the standard method of calculating the apportionment in regulation 101(2)(d) which is only concerned with the value of taxable supplies made in the current period.

61. In summary Ms Brown submits for HMRC: 1) The normal statutory rules governing the calculation of the apportionment of residual input tax that is recoverable, allows HMRC to calculate the apportionment by: (a) First applying a depreciated value to the VAT cost incurred (assuming an economic life of 5 years) to reflect the exempt use of the goods prior to the EDR; (b) Then applying the “appropriate recovery rate” to that depreciated amount to determine the quantum of recoverable residual input tax. 2) The recovery rate that HMRC has used is based upon the projected taxable use for the remaining years in question using ACSL’s projected figures. 3) The apportionment needs to be applied to the depreciated value as at the EDR in order to reflect the fact that ACSL’s pre-registration supplies were wholly exempt and submits that this is in line with first principles, specifically sections 24 to 26, regulation 101 and the decisions of Douros (t/a Olympic Financial Services) v C & E Comrs (1994) VAT Decision 12454 , Byrd (t/a G N Byrd & Co) v C & E Comrs (1994) VAT Decision 12675, Schemepanel Trading Ltd v C & E Commrs , QB [1996] STC 871 and Wilf Gilbert (Staffs) Ltd v HMRC (2007) VAT Decision 20170. 4) Ms Brown explains in her skeleton argument that: “HMRC’s approach takes account of the fact that ACSL had no right to recover VAT at the time the costs were incurred. The relief that ACSL has been granted is exceptional relief and fairly and reasonably considers both the wholly exempt use when the costs were incurred and the partially exempt use after registration. This approach is generous as ACSL is in a better position than if it had been registered at the time the goods were acquired where no VAT would have been recoverable (assuming no intention to make taxable supplies at that time). …HMRC are treating the pre-registration VAT as if it were input tax and so it follows that recoverability must be determined by reference to when it was actually incurred. It also needs to reflect actual as well as future intended use to produce a fair and reasonable outcome.” 5) The legal test for attribution of input tax to taxable supplies using a partial exemption method is whether it is fair and reasonable and that to be successful in their appeal, ACSL must show that HMRC’s computation is unfair and unreasonable or that ACSL’s method is more fair and more reasonable.

62. Despite some of the language used by HMRC in their correspondence and some of the submissions made by Ms Brown, that suggest that there is some element of discretion outside of regulation 111 and that the Tribunal must determine whether HMRC has acted reasonably, this appeal does not concern the exercise of HMRC’s discretion.

63. Section 26(3) does, as Ms Brown submits, empower HMRC to make regulations for “securing a fair and reasonable attribution of input tax,” and section 26(3)(a) specifically provides for regulations for “determining a proportion by reference to which input tax for any prescribed accounting period is to be provisionally attributed to those supplies.” HMRC has exercised that power by making regulation 101. Section 26(3) does not give HMRC any wider discretion to override the methods set out in regulation 101, in circumstances where they consider that the regulation 101 method results in an attribution that is not fair and reasonable.

64. If HMRC consider that a fair and reasonable apportionment needs to be made between pre- and post-EDR use of goods and services on which VAT has been paid as a first step before the calculation of how much of that input tax can be deducted against output tax pursuant to sections 25 and 26 and regulation 101, this could arguably be done as part of the exercise of its discretion under regulation 111. We do not make any finding as to whether it would be reasonable for HMRC to exercise its discretion under regulation 111 in this way in this appeal or more generally because that issue is not relevant to this appeal and we have not heard any submissions on it.

65. What we do find however is that, beyond the discretion in regulation 111 there is no further discretion that allows HMRC to make a “fair and reasonable” apportionment that is not within the parameters of regulation 101.

66. Wilf Gilbert (Staffs) Ltd v HMRC (2007) VAT Decision 20170, on which HMRC rely, was premised on different facts because it was considering the exercise of HMRC’s discretion under regulation 111. As stated at [10] of that decision “…. It must be assumed that, in granting a discretion to the Commissioners, Parliament intended that they should exercise it in such a manner consistent with the objectives of the Sixth Directive and the 1994 Act .”

67. We do not disagree with that statement but it is of no application to the facts of this appeal, as we are not considering the exercise of HMRC’s discretion to allow all of the pre-registration VAT to be treated as input tax. We are concerned only with the application of the legislation to the Pre-Registration Input Tax to determine the extent to which it is deductible against output tax.

68. We turn then to consider how to apply the normal rules of deductibility governing input tax to the Pre-Registration Input Tax.

69. HMRC relies on Article 167 of Directive 2006/112 which provides that “A right of deduction shall arise at the time the deductible tax becomes chargeable.”

70. Based on this fundamental principle of input tax deductibility, Ms Brown submits that the Pre-Registration Input Tax is only deductible to the extent that it would have been deductible in the period in which it was paid. She states in her skeleton argument as follows: “Attribution in these provisions is by reference to the period in which the VAT was incurred. On the facts of this appeal, the supplies by ACL in that period were wholly exempt from VAT with no evidence of any intention to make taxable supplies. The prior use of the goods cannot be ignored and to do so would create a falsehood.”

71. Mr Ripley acknowledges that there is a slight oddity in applying section 26(2)(a) to an amount “treated as input tax” pursuant to regulation 111 because the goods and services to which it relates were supplied in a different period to the period in which that input tax is claimed. However Mr Ripley submits that the deductibility of the Pre-Registration Input Tax should be calculated by reference to the period in which it is claimed and not the period in which it was paid and would ordinarily be deductible.

72. In our view, if HMRC’s analysis is correct and the Pre-Registration Input Tax is not deductible because ACSL was making exempt supplies at the time it was incurred, this does not give HMRC a discretion to apply regulation 101 in such a way as to take into account pre-registration usage. It would simply require the attribution of the Pre-Registration Input Tax provided for by regulation 101(2) to be made as at the time of payment of the pre-registration VAT by ACSL. If, as HMRC contend, this would make none of the Pre-Registration Input Tax deductible, this would be because all of the Pre-Registration Input Tax would fall to be excluded by regulation 101(2). If that is the case we were not directed to any legislation that then gave HMRC a discretion to allow input tax that is specifically disallowed by the legislation.

73. Regulation 111 does not state explicitly for which period the amount treated as input tax is to be so treated. Article 167 of Directive 2006/112 sets out a fundamental principle of deductibility but regulation 111 is entitled “Exceptional claims for VAT relief” and allows for input tax to be claimed, in circumstances where it would not normally be deductible.

74. As stated by the VAT Tribunal in its decision in the case of Byrd (t/a GN Byrd & Co.) v C & E Comrs [1995] BVC 1228 at page 1230: “It is a commonplace that where an enactment requires or permits something to be treated as what it is not, one has to consider what relevant consequences consistent with the intentions of the legislation would ensue if it had the quality one is told to assume it has and give effect to them.”

75. Turning therefore again to the legislation, regulation 111(1) provides that a claim for pre-registration VAT to be treated as input tax must be made in accordance with (3) which in turn provides that the claim must be made: “on the first return the taxable person is required to make”.

76. Further, as sections 25 and 26 make clear only a taxable person can deduct input tax so it is only deductible after the EDR.

77. It follows in our view that when dealing with VAT that is “treated as input tax” pursuant to regulation 111, the intention of the legislation is that it is treated as input tax for the period in which it is claimed. For these purposes, the references in sections 25 and 26 and regulation 101 to a “period” are to the period in which the regulation 111 claim was properly made and not the period in which the goods were supplied and a claim for a deduction of input tax would ordinarily be made. So in 101(2)(a) reference to “goods or services supplied to the taxable person in the period” must be read as “goods or services claimed by the taxable person in the period”.

78. To do otherwise would require a further artificiality of treating a non-taxable person as a taxable person, because only taxable persons can deduct input tax. For ACSL it would also involve going back up to four years and for each period applying the relevant attribution method of input tax to taxable supplies. In our view this would involve unnecessary artificiality and complexity and cannot have been the intention of regulation 111.

79. We find therefore that the deductibility of the Pre-Registration Input Tax falls to be considered in the year in which it is claimed because it is the most natural reading of sections 25 and 26 and regulation 101 in this context and it requires the least amount of artificiality and complexity.

80. It follows that we find that there is no statutory basis to take account of pre-registration use when calculating deductibility of the Pre-Registration Input Tax. Further as we have found above, there is no discretion available to HMRC to limit how much of the input tax can be credited against output tax on the basis of pre- and post-EDR usage.

81. Our findings are supported by the April 2003 Consultation document (VAT: Making input tax recovery fairer) which we were referred to by Mr Ripley. This consultation stated that: “3.10 To increase fairness in the recovery of VAT, and to apply the principle that deduction is allowed in so far as the expenditure is used for the purpose of a businesses’ taxable supplies, newly registered taxpayers would need to take into account the use they have made of a purchase prior to VAT registration when determining how much VAT they can recover.” In order to bring this into effect the proposal was to: “introduce a requirement on registering taxpayers to apportion the VAT incurred before registration so that they recover VAT in the same taxable proportion to the use of the goods and services”

82. The Consultation document proposed various methods for making the necessary apportionment including: “1. Time-based method . This method can be applied by recording of the use of an object before registration and comparing this to its expected lifespan. For example a trader might estimate that a van purchased 3 years before registration has a total lifespan of 10 years. The trader would deduct three tenths of the VAT incurred from his claim to represent the pre-registration use of the item….

3. 5-Year depreciation . Also known as ‘straight-line depreciation’ this could be applied to all goods reducing by 20% the deductible VAT that may be recovered for each year of use before registration. Therefore goods which are 3 years old at registration must be depreciated by 60% (20% per year) and 40% VAT recovered accordingly. If a taxpayer felt that 5 years is too short to reflect the lifespan of the item, he can use time-based method above.”

83. The 5-year depreciation method set out above is the method that HMRC has applied to ACSL’s Pre-Registration Input Tax.

84. Following the consultation responses it was decided not to proceed with this proposal because: “subsequent analysis suggested that it could have resulted in a net cost for many small businesses”

85. Regulation 111 remained unchanged and in its current form. At the time of the consultation therefore, the Government was clearly of the view that it would require a change to regulation 111 for this method to be applied to take into account pre-registration use when apportioning pre-registration VAT. No such change occurred.

86. Both parties referred us to the Revenue and Customs Brief 16/2016. In our view this does not support HMRC’s position. For example it states: “UK law allows a business registering for VAT to recover tax they have incurred on goods and services before their effective date of registration (EDR). This allows the recovery of VAT against goods and services as long as they’re used by the taxable person to make taxable supplies once registered ” [bold added]

87. In the above HMRC clearly does not interpret regulation 111 as allowing a business to treat an amount as input tax in the year it was incurred but in the year that it is claimed, allowing it to be deducted to the extent that the pre-registration goods or services are used to make taxable supplies after EDR. There is no suggestion from the above that HMRC consider it necessary to look back and allow the amount treated as input tax to be recovered only to the extent that it was used to make taxable supplies at the time it was incurred.

88. While neither RCB 16/2016 nor the consultation document are legally binding, they support our findings, that where HMRC allows pre-registration VAT to be “treated as input tax” pursuant to regulation 111, it is allowing it to be treated as input tax for the period in which it is claimed and that there is no statutory basis or discretion available to HMRC to take pre-registration usage into account.

89. We turn then to consider how much of the Pre-Registration Input Tax is deductible by reference to the post EDR use of the relevant goods and services and the application of regulation 101(2)(e) to the Pre-Registration Input Tax.

90. Given our findings above, the rate of apportionment should be the same for Pre-Registration Input Tax as for post registration input tax claimed in the Period. We will address the issue of the correct rate for both below. the Appropriate rate

91. HMRC accept that ACSL can use the “use-based method” set out in regulation 101(2)(e). The use based method is a variation on the standard method, both of which are set out in paragraphs [44] and [45] above.

92. Effectively the calculation that is required here is to attribute to taxable supplies such proportion of the Pre-Registration Input Tax as bears the same ratio as the taxable supplies to total supplies over a period. Recovery Rate for Goods

93. Regulation 101(e) does not state the period in which the goods or services are “to be used by him in making taxable supplies”.

94. ACSL has provided a projection over a 5 year period of the % of its supplies each year that will be taxable supplies.

95. HMRC state that a 5 year period is a reasonable period to consider for goods because this is reflective of ACSL’s depreciation policy in its accounts of 20% per year on a straight line basis. Further Ms Brown submits that 5 years is a reasonable proxy which takes account of the fact that goods have varying lifespans, some more and some less than 5 years.

96. We heard evidence from Dr Linnell that whilst she accepted that it would not be reasonable to look at each item and assess its useful economic life (UEL), goods should be separated into different types according to their typical UEL and calculations could be made on that basis.

97. We consider that in the context of this appeal, where some goods were bought prior to the EDR, and some afterwards, and where goods have different UELs which, based on Dr Linnell’s evidence range from 2 – 20 years, calculating the apportionment based on the use-based method and projections of turnover over a 5 year period is a workable and reasonable basis to calculate the use-based method apportionment.

98. Our understanding is that the parties agree that 5 years is an appropriate period in which to assess the extent to which the goods are to be used for the purpose of the use-based method in the context of our findings above. In any event we find that 5 years is an appropriate period.

99. Ms Brown states in her skeleton argument that this results in an average recovery rate of 77% and we understand that this is the recovery rate that the parties have agreed for post-registration input tax on goods. This is on the basis of projected total supplies over 5 years of £11,315,460 and projected taxable supplies over 5 years of £8,692,868.

100. ACSL has subsequently submitted that because time has passed since the Period, ACSL now has actual turnover figures for a number of the 5 years since the EDR which are actually higher than originally projected and therefore result in a higher recovery rate applying the use-based method. This, in Ms Brown’s submission, is only available with hindsight and she submits that there is no legal mechanism to go back and amend the projected figures to increase or decrease the effect of a partial exemption method retrospectively. It is a matter for ACSL to put forward reasonable projections in the first place.

101. Our understanding is that ACSL only puts forward the increasing turnover argument if we find in favour of HMRC on the issue of whether pre-registration usage should be taken into account when apportioning the Pre-Registration Input Tax. As we have found in favour of ACSL on this issue, the increasing turnover point may therefore be academic. However if it is not, we find for HMRC on this point, namely that the projected turnover at the time of the claim is the basis on which the use-based method should be calculated and it is, as Ms Brown submits, not open to ACSL to adjust that projection retrospectively, once they have actual turnover figures. Recovery Rate for Services Pre-Registration Input Tax

102. As we do not accept that pre-registration usage should be taken into account when calculating the recoverability rate, HMRC’s secondary argument in relation to Pre-Registration Input Tax on services is that there “should be an adjustment to reflect a more accurate estimate of use”.

103. HMRC refer to a document produced by ACSL that shows VAT paid on pre-registration services and an estimate of their economic life ranging from 0.5 years to 10 years. Post-Registration Input Tax

104. For post registration input tax HMRC assert that they have restricted recovery to capital not revenue costs. There was some misunderstanding between the parties as to what HMRC meant by revenue costs. In their letter of 21 March 2022, HMRC asserted that: “capital costs… mean items which appear on ACSL’s balance sheet and revenue costs to be otherwise in terms of goods and services which would not be reflected on the balance [sheet] and are typically consumed and used on an ongoing short to medium term basis.”

105. As a result ACSL had not provided an analysis of post registration revenue and capital costs claimed in the Period as they did not accept HMRC’s premise that only input tax incurred on goods and services that were reflected on the balance sheet was recoverable.

106. ACSL did accept at the hearing that it can only claim post registration input tax that it had incurred on goods and services that were not fully consumed before any taxable supplies were made and that have an enduring economic life. HMRC acknowledged at the hearing that this is what they had meant by capital costs and on this basis ACSL agreed to provide an analysis of the input tax incurred on such goods and services. Use-Based Method on Services

107. We find that only services that are not fully consumed before any taxable supplies are made and that have an enduring economic life should be taken into account when calculating how much input tax on services is allowed under the use-based method. Subject to this, the use-based method applied over a five year period is reasonable for services in this appeal. The rate of recovery for the input tax on those services should therefore be the same as for that on goods. conclusion

108. For all the reasons set out above we allow the appeal and find that for the Period: 1) Only goods and services that have not been consumed prior to the first chargeable supply and which have an enduring economic life are deductible; 2) Subject to (1) above the Appropriate Rate must be applied to the full amount of Pre-registration Input Tax and post registration input tax incurred on goods and services. 3) The recovery rate agreed between the parties for post registration input tax of 77% is the Appropriate Rate. NEXT STEPS

109. There will need to be adjustments made to take account of our findings set out above.

110. We direct the parties to agree an updated calculation of the deductible input tax for the Period and confirm to the Tribunal that they have agreed the calculation or that agreement cannot be reached within 30 days of the release of this decision.

111. If agreement cannot be reached, we direct ACSL to prepare its proposed updated calculation. This updated calculation must be submitted to the Tribunal and served on HMRC within 45 days of release of this decision. HMRC will then have 14 days from receipt of ACSL’s calculation to submit to the Tribunal and serve on ACSL its written submissions on ACSL’s calculation, together with its own proposed updated calculation. The Tribunal will then determine the deductible input tax for the Period. Right to apply for permission to appeal

112. This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. The application must be received by this Tribunal not later than 56 days after this decision is sent to that party. The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice. Release date: 13 th FEBRUARY 2026