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HMRC internal manual

VAT Partial Exemption Guidance

Other Partial Exemption issues: changes in intention or use: intention and first use

Over the years much has been made of the idea of a first supply rule. That is to say recovery is to be determined according to the first use of goods and services. The principle is often misunderstood in that while recovery should be allowed according to how a business intends to make use of goods and services received, it is quite reasonable for him to intend to use goods and services in a variety of ways. It is the intention at the time of receipt of the supply that is the essence. The matter can be best explained through four cases.

Firstly, two High Court cases, Briararch Ltd and Curtis Henderson Ltd (STC 732 heard together), which were concerned with property and involved a similar principle in each case. Of the two the latter case is the important one, as Briararch goes back to the period before 1 April 1989 when it was possible to make a zero-rated grant of a major interest in a commercial building. The particular facts of the Briararch case cannot now arise.

The circumstances of the Curtis Henderson case arose frequently in the early 1990s because many developers built dwellings with the intention of granting a zero-rated major interest (usually an outright sale of the freehold) and correctly attributed input tax to the intended taxable supply, recovering it in full. Due to the collapse of the property market, these businesses found themselves unable to sell their newly built properties and, in order to produce some income, were obliged to let them on a short-term basis, thus making supplies with no right to deduct.

Since the intended taxable supply had been replaced by an actual exempt supply, assurance officers invoked the “clawback” provisions to recover the input tax incurred in building the properties. However in both of the cases, the High Court supported the Tribunal who had held that, because the business still had an underlying intention to make a taxable supply, the input tax had to be apportioned to take account of future supplies with a right to deduct and only a proportion could be recovered under the ‘clawback’ provisions.

In contrast to this decision you should consider the case of Pembridge Estates (VTD 9606). This was a case where a company refurbished a flat with the declared intention of letting it out for holiday accommodation. It subsequently sold the flat after two weeks of holiday letting, to one of the directors of the company for his personal use. The Tribunal found that at the time that the first supply of holiday letting was made, there was no intention by the company to sell the flat. The business was entitled to the input tax on the refurbishment in full. When the input tax was initially deducted, the business had an intention to make taxable supplies. This intention was fulfilled. He subsequently made another supply of a different liability but since he had already fulfilled his intention, no adjustment was required.

The fourth case in this area to consider is Cooper & Chapman (Builders) Ltd (STC 1) who owned a property, which was also refurbished with the intention to make supplies of holiday letting. The building had several floors of which only one was immediately used for the declared purpose; as a result not all the refurbishment supplies were used. The company then entered into an agreement with an overseas company to supply the whole property for long term accommodation for its employees - an exempt supply. The High Court supported the Tribunal’s rejection of the company’s claim that the use of the one floor amounted to the use of the whole building and in this case, ruled that the input tax had to be apportioned according to the first use of each floor.