The First-tier Tribunal Tax Chamber released its judgment on The Towards Zero Foundation v HMRC  UKFTT 226 (TC) in July this year, where it was held that input VAT incurred on "free" safety testing provided by The Towards Zero Foundation ("TZF") was in fact recoverable.
HMRC has indicated it will not be appealing the Tribunal's decision. Therefore the verdict acts as a persuasive precedent to businesses and charities that adopt a loss-leading model, as well as important commentary on the "direct and immediate link" test (as per the Sveda case).
Promoting vehicle safety through publishing crash test results
TZF is a charity working towards a world free from road fatalities by promoting vehicle safety through car crash testing. The charity's establishing, and continuing, objective through the operation of Global New Car Assessment Programmes ("NCAP") is to publicise more stringent vehicle crash tests than those required by regulation, in the view of encouraging a market for safety. The NCAP methodology is to identify vehicles that are likely to fail to reach the required regulatory safety standards. If a vehicle fails to meet the standards when subject to a crash test, these test results are publicised. (This initial phase of testing was funded by TZF). As the negative test results garner increasing publicity and consumer awareness, manufacturers are forced to improve the safety of their vehicles. Manufacturers then proactively seek and pay for the testing of these improved models by TZF so that positive test results can be publicised.
Do crash tests carried out for "free" constitute a business activity?
The parties disputed whether crash tests carried out without charge to the manufacturer (the "free" testing) could be considered as a business activity and whether input VAT incurred on testing was recoverable.
HMRC deemed these free-of-charge tests to be a non-business activity and therefore not recoverable for VAT purposes. As a result, HMRC issued assessments for input VAT of £152,311 which it claimed was "overclaimed" by the charity on the basis that there should have been a 40% restriction on general overhead input tax recovery.
In response, TZF argued that the free-of-charge tests were central to TZF's overall business model as it was crucial for the charity to initially test the vehicles independently, without the support of manufacturers, to establish consumer credibility. It constituted a single business activity (rather than two separate phases of testing), as there was a direct link between the "free" tests and the manufacturer-funded tests. It would not make practical nor commercial sense for the charity to operate one phase of testing without the other, as they were in fact intrinsically linked and, therefore, constituted a single business activity.
The Tribunal, using the Sveda case by analogy, regarded the "free" testing costs a "necessary precursor to making taxable supplies". The "free" testing was viewed as an "inherent and integral part" of TZF's overall business activity and that it could not be considered in isolation. It was also held that TZF's articles of association did not preclude it from engaging in trading activity, and its philanthropic objectives did not restrict the charity from making business supplies.
As a result, the Tribunal held that the appeal should be allowed and HMRC's assessments set aside as the "free" tests did not constitute a separate non-business activity.
Mishcon de Reya acted for TZF.
Les Allen, Consultant, Barrister in the Dispute Resolution department at Mishcon de Reya said: "Despite only having persuasive authority, this decision provides helpful commentary on the business/non-business supply test, as well as what constitutes a "direct and immediate" link.
The outcome will provide those with a similar loss-leading model with guidance as to what can amount to a business activity and highlights that the distinction between business supplies is not always clear cut, being dependent on the facts before the Tribunal.
Further, given that HMRC's current policy on business/non-business activities states that "there should be no reliance on an organisation's overall objective or profit motive", this decision indicates that the Tribunal will continue to apply legal principles (as well as the relevant European authorities) on a case-by-case basis, despite the current HMRC policy place.
In this case, the testing conducted very much fits into the loss leader model, as this was necessary to enable TZF from carrying out its supplies. HMRC saw these as supplies as without consideration, however this ignored the true nature of the company and its charitable objective (as, without the original "free" testing", it would not be possible for future taxable supplies to take place)."