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Articles 24.6.14

Residual Input Tax – Too Good To Be True?

Articles 24.06.2014

I was fascinated by the First-Tier Tribunal decision earlier this year in The Roald Dahl Museum and Story Centre v HMRC. This was a VAT case. The museum is tiny as museums go. In the year to 31 March 2012, it attracted 56,075 visitors (a bit over 1,000 a week) who paid admission fees of £225,359. The museum shop almost matched that income at £223,979. The museum also has a venue for corporate meetings. The room hire for such meetings is charged on a per capita basis and delegates are entitled to also visit the museum. The Roald Dahl Museum claimed partial exemption. It made exempt supplies of admissions, taxable supplies of room hire and taxable (largely zero-rated) supplies in the shop. The partial exemption rules say that expenditure used solely to generate exempt supplies must be matched to those supplies and as such is not deductible as residual input tax. Expenditure used solely to generate taxable income is similarly matched with that income and deductible in full. Where expenditure is incurred to generate both exempt and taxable supplies, it is residual input tax and has to be apportioned (subject to a de minimis exemption) in the ratio that exempt supplies bear to taxable supplies for the year, with the part apportioned to taxable supplies being deductible. The HMRC test as to whether expenditure is attributable to taxable or exempt supplies is whether there is a direct and immediate link between the expenditure and the supply. The Museum has exhibits in two galleries, the Bay Gallery and the Solo Gallery. It spent a bit over £500,000 on the refurbishment of the Solo Gallery. Much of this was on building within the gallery a replica of Roald Dahl’s writing hut, which stands in the garden of his home, and transporting to it the contents of the actual writing hut. The Museum claimed that the £100,000 VAT on the refurbishment was residual input tax, so claimed to deduct roughly 50% as being the part apportioned to the taxable supplies. HMRC said that it related solely to the exempt admission charges, so no part of it was deductible. The Museum claimed that the items sold in the shop are designed to compliment the displays and is very much part of the visitor experience. It also said that the museum could not survive without the shop. The Tribunal said that neither of these created a direct and immediate link between the shop sales and the gallery. All of the items sold in the shop could be sold in any shop anywhere and, indeed, that is what happens. Accordingly the museum is not essential to the shop. Therefore there was no direct or immediate link between the shop sales and the gallery refurbishment. The Museum next claimed that as it gave free museum admission for corporate events, the galleries were directly linked to such taxable events. The Tribunal disagreed. It felt that a company was only buying the room hire. The right of admission to the museum was not an aim in itself, but simply a means of better enjoying the conference room. Accordingly refurbishing the galleries did not have a direct link to the room hire. The proximity to the museum might make the venue a desirable one for corporate events, but the event could still be conducted successfully without any delegate visiting the museum. It is questionable whether that is the right test. The museum director had given evidence that companies are very much looking for an inspirational venue for their meetings and therefore that unlimited access to the galleries was a key factor in them choosing to hire the room. It is not clear why the Tribunal did not accept that gave a direct link between the gallery and the room hire. It seems to have started from the point that the right of the entry to the museum was simply part of the supply of conference space. While that may be right, that does not answer the question whether the refurbishment of the museum is a cost component of the supply of conference space in the same way as, for example, putting pictures on the walls of the conference room would be. Whether or not there are pictures on the walls would not prevent the conference taking place but if the existence of the pictures is an important factor in a customer’s mind, it is surely a cost component. Why should museum entry be different? Be that as it may, the Roald Dahl Museum had one last throw of the dice. It had commissioned the writing of a book, “Inside Roald Dahl’s Writing Hut”. This contains descriptions and explanations of the items in the hut exhibit. There are tethered copies of this book inside the gallery which visitors can look at when viewing the hut display. This was felt more sensible than to have, for instance, touch-screen displays in the gallery to explain the items. It had the added benefit that extra copies could be sold in the shop. The museum had 1,000 copies printed even though it only needed a few in the gallery. Eureka! The Tribunal accepted that this book was a cost component of the £500,000 gallery refurbishment. The refurbishment was driven by the writing hut exhibit and the books tethered beside the exhibit were integral to a visitor’s enjoyment of that exhibit. The cost of producing the book was also a cost component of the VATable copies sold in the bookshop. Accordingly the expenditure was partly to service VAT exempt visitors and partly to supply VATable book sales. The tax was therefore residual and the museum was entitled to recover £50,000 of VAT! I don’t often feel sorry for HMRC, but I do on this occasion as the decision seems to me to defy common sense. I accept that tax is not always logical, but it mainly is. It would be logical for the VAT on the cost of producing the book to be residual input tax. But it seems a huge leap to say that, because the book serves two functions, the cost of creating the replica hut, of altering the Solo Gallery to accommodate it, and of transporting the exhibits from the actual hut to the replica and displaying them, also serves two purposes. That seems to me to turn the facts on their head. The book is a commentary on the display; the display was not created to enable the book to be written. So how can the costs of the display be a cost component of the book? They are clearly not. I am in the process of having my house redecorated. I am writing this blog at my desk at home which is in a redecorated room. I may draw inspiration from the newly painted wall in front of me, so the decoration of that little bit of wall could be directly related to this blog. But I would not have the nerve to claim that makes the redecoration of my entire house a cost component of this blog. In the museum’s case, the whole £500,000 for the refurbishment (including the production of the book) seems to have been paid to a single supplier, Outside Studios. However it is hard to see that this makes a difference. If the museum asked Outside Studios for a breakdown of its bill, it would surely get it. The cost of the book may be significant because it may have required a lot of research. But even so, it is hard to envisage it exceeding more than 10-15% of the cost of the refurbishment. It would make sense to regard the part of the cost that relates to the book as residual. It makes no sense to treat the entire cost of the refurbishment as residual input tax. I have used a single builder for my redecorations. Perhaps I should have a rethink. Maybe I am entitled to treat the whole of the cost of redecorating my house as residual input tax because a few square feet of wall space has inspired by blog!