PE21000 - Partial Exemption principles: attribution
Definition of attribution
Attribution is the process of setting input tax against the supplies made or to be made using that input tax. We attribute input tax incurred on supplies received, rather than purchase invoices, bearing in mind that several supplies can be included on one invoice, or a single supply can be split over several invoices.
There are two main stages to this process. These are:
- direct attribution; and
- apportionment of the remaining tax.
Direct attribution
This is the identification of input tax on supplies that are wholly used, or to be used, in making taxable supplies, or wholly used, or to be used, in making exempt supplies. Input tax used, or to be used, in making taxable supplies can be recovered in full. Input tax used, or to be used, in making exempt supplies, generally cannot be recovered. Any input tax which cannot be directly attributed is termed 'non-attributable' and is carried forward to the next stage of the process.There is no provision for making ad hoc splits of the non-attributable input tax at this point, even if the full final use is known.
Whether any particular input tax incurred can be directly attributed is a question of fact to be decided on the particular circumstances of each case. It must be decided whether the input tax has been used, or will be used, in making a particular output supply or supplies. Case law in this area has confirmed that ‘use’ can be established through the identification of a direct and immediate link between the input costs and those outputs.
It is possible for costs incurred to have a direct and immediate link with more than one supply type. Where the output supplies in question are a mixture of taxable and exempt, then that input tax will be residual and must be apportioned.
Another concept commonly discussed in the case law is cost component. Where input costs have been used, or will be used in making an output, they are said to form a cost component of the output.
This concept is derived from the case law on attribution (see PE21500), which has made clear that direct attribution of input tax to a specific output supply can only occur where the input costs have been used in making the output, such that there is a direct and immediate link between the two.
This prevents any “look through” being applied to input tax incurred in respect of output transactions further downstream and where any link between that input tax and downstream supplies is either indirect and/or not immediate. VAT is a transaction-based tax and costs incurred must therefore be linked to the immediate supplies made using them. What the business then does with revenues generated by those linked supplies is irrelevant.
A direct and immediate link requires a business to demonstrate more than just the existence of a commercial or economic link between an input and an output. It is not sufficient to demonstrate a ‘but for’ link between the two transactions, where the output transaction would not have been made but for the input.
A helpful illustration of an indirect ‘but for’ link was provided in the case of Royal Opera House [ROH) (2021 BVC 12). ROH argued that costs incurred in making its productions were directly and immediately linked to its taxable supplies of catering, because catering would not have been supplied if there were no performance for which exempt tickets were sold. However, the Court of Appeal dismissed this as no more than a commercial link. The production costs had been used in putting on the productions, and the link to the bar and catering supplies was indirect.
By contrast, in Mayflower Theatre (2007 STC 880), the Court of Appeal found that there was a direct and immediate link between the theatre’s production costs and its taxable supply of programmes. This was because the productions provided the content for the programmes, and so production costs had been used in supplying programmes. The production costs were treated as residual because they had a direct and immediate link to both the programmes and the exempt supplies of performance tickets.
In general, there will be a close temporal link, with the input coming before, but not greatly before, the output towards which it is leading. It is possible, however, for the input to be incurred either well before the output is made, or after the output is made, and still have a direct and immediate link.
An example of the former situation is that the costs of constructing a building are incurred over a considerable time span but all of them are immediately linked to the supplies made of (or from) the completed building.
The latter can arise, for example, where there are obligations on the supplier under a contract, which require further costs to be incurred after a primary supply of goods and services has been made.
Cost component
The concept of ‘cost component’ derives from European VAT legislation, which refers to VAT being chargeable ‘after deduction of the amount of VAT borne directly by the various cost components’ (Article 1 of the Principal VAT Directive).
A cost can be a cost component of an output supply even if the cost value is not fully recovered by the price of that output supply.An input is a cost component of an output where it has been used for the purposes of making that output.
This was confirmed by the Court of Justice in Volkswagen Financial Services (VWFS) (2018 BVC 45). In this case, VWFS incurred costs which were used in its business as a whole, rather than in any specific supplies. It included the costs in the prices charged only for its exempt output supplies. However, this did not change the fact that the inputs were cost components of both those supplies and VWFS’ taxable supplies, because the inputs had been used in the general business.
Interaction of direct and immediate link and cost component
The concepts of direct and immediate link and cost component are closely related, in that they both centre on the determination of use and whether deduction of input tax is possible. However, they are not exactly the same as each other. Cost component refers to something that has been used in the making of an output supply, such that it constitutes part of the cost of that supply.
Direct and immediate link refers to the test required to determine whether a particular cost has been used in the making of a supply, thus making it a cost component of that supply.
In practice, therefore, an input cost that has a direct and immediate link to an output will also be a cost component of that output, and so there could not be a situation where a cost could be one, but not the other.
Supplies received as a consequence of supplies made
In general, supplies received as a consequence of making an output transaction, rather than as part of the normal cost components of making the supply, are not cost components of that output transaction. There is thus no direct and immediate link and such costs will normally be non-attributable. These costs include such things as defending litigation for alleged shoddy work or poor advice given.
Intention, change of intention and wasted costs
As any entitlement to deduct arises when VAT is incurred, it is the business' intention at that point that determines how it should be attributed. If that intention is subsequently frustrated so that the costs are wasted and put to no use in the business, then there is no change to this initial entitlement. If, however, costs are put to another use within the business then the clawback and payback rules may apply. These are fully explained in PE61000. If the change in intention happens within a partial exemption longer period, then that change must be reflected in the longer period adjustment.
General overheads
Input tax on costs which do not have a direct and immediate link with any particular supplies, but instead are used in the business as a whole and so are seen as having a direct and immediate link with all supplies, are known as general overheads and must also be apportioned. Guidance on apportionment can be found at PE23000.