Supreme Court dismisses attempt by borrower to recover VAT paid on fees incurred preparing a strategic review of its distressed business where report was addressed to lenders

In a case with implications for all stakeholders in distressed businesses, the Supreme Court has issued its judgement in Airtours Holidays Transport Ltd v HM Revenue & Customs. By a majority of 3:2, the Court determined that Airtours was not entitled to recover, by way of input tax, VAT on fees paid to PwC for the preparation of a viability report addressed its lenders.

Background to the Viability Report

  • In 2002, the business operated by Airtours Holidays Transport Ltd ("Airtours") was experiencing severe financial distress.
  • At this time, Airtours had borrowings with circa. 80 financial institutions.
  • In an effort to secure a refinancing of its debt, and to address lender concern as regards achievability, PwC was instructed to undertake a strategic review of Airtours' business and to prepare a report on the viability of Airtours' restructuring proposals.
  • The terms and conditions of PwC's engagement were contained in a letter addressed to "the Engaging Institutions", i.e. Airtours' lenders.
  • The professional fees payable for preparing the report, together with an initial retainer, were all paid by Airtours. VAT was charged, and paid, on all invoices.

The question then arising was whether Airtours was able to deduct VAT paid on those invoices as input tax in its VAT returns for the relevant period. HMRC challenged this, on the basis that the professional services provided by PwC were not "attributable to... supplies made or to be made to" Airtours, as required for deduction under the Value Added Tax Act 1994 (it was not in contention that services had been supplied by PwC to Airtours' lenders).

A supply of services?

In considering whether the VAT charged and paid by Airtours on all invoices was able to be recovered, the Supreme Court closely considered the legislation in the context of the particular terms of PwC's engagement.

In determining whether services had also been supplied by PwC to Airtours, the Supreme Court posed two questions: firstly, whether, under the terms of the contract, PwC agreed with Airtours that it would supply services; and secondly, whether, nonetheless, there was a supply of services by PwC to Airtours.

On the particular facts of this case, the Court held that neither question could be answered in the affirmative.

In assessing the first question, the Court confirmed that it was sufficient for Airtours to demonstrate that PwC was under a contractual obligation to Airtours to supply services to Airtours' lenders. There was no need for Airtours to demonstrate that services were provided to it direct.

Lord Neuberger, delivering the majority opinion, cited six facts which, on the basis of the contractual documentation relative to this case, caused him to conclude that PwC did not have a contractual commitment to Airtours. These factors included the lenders being the sole addressees of PwC's engagement letter; the confirmation contained in that letter that Airtours would be provided with a copy of the final report - which may be redacted; and the explicit acceptance by PwC of a duty of care to the lenders, while failing to acknowledge any equal or comparable duty to Airtours. Further, the Court was not satisfied that either test for implying the duty as a term of the contract - being either that it was necessary for business efficacy or, in the circumstances, was a term so obvious that it went without saying - was met.

On the second question, the Court noted that in the absence of a contractual right to receive supplies (as here), the payer would only be given the right to reclaim VAT paid by way of input tax if the documentation did not reflect the economic reality of the situation - noting that it was competent for a third party to pay the consideration for a supply. The Court was satisfied in this case that the documentation did reflect economic reality.

Implications for interested parties

The Court confirmed that decisions about the application of the VAT system are highly dependent upon the factual situations involved.

However, the case does contain some key messages for stakeholders in a distressed business who may be assessing potential cash leakage via output VAT:

  1. It is essential that the particular terms of the contract(s) for services for which the business is liable are accurate, clearly drafted and properly reflect the party or parties entitled to the services to be provided.
  2. In the absence of an express entitlement to those services, the court will imply an entitlement under the contract only where necessary for business efficacy or, in all of the circumstances, is so obvious that it goes without saying.
  3. In the absence of an express or validly implied contractual entitlement to services, the court will only take the step of looking behind the contract where that contract does not reflect the economic reality of the situation - which does not automatically arise when a third party is making payment for supply of services.

As a finalpoint,it is important to note that this was a majority decision with strong dissenting judgements offered in this case by two of the three Supreme Court judges, of the view that Airtours was entitled to deduct VAT; the narrowness of the split suggesting that this case may not be the final and conclusive authority on this matter.