Airtours not entitled to recover VAT on accountants' report to its lenders, Supreme Court confirms

Three Supreme Court judges ruled that PwC's services were not "supplied to" Airtours, but rather to the 80 or so "engaging institutions" referred to in the contract. Airtours itself was only a party to the contract "for the purpose of agreeing to pay PwC's fees, to provide PwC with an indemnity, and to acknowledge the cap on any damages for which PwC may be liable", said Lord Neuberger, giving the judgment of the court.

However, the "powerful dissenting comments" of Lord Clarke and Lord Carnwath were "likely to cause considerable debate in later cases", according to VAT expert Darren Mellor-Clark of Pinsent Masons, the law firm behind Out-Law.com.

"The conclusion that Airtours had no enforceable right against PwC despite having paid £200,000 could not, in Lord Carnwath's view, be correct either as a contractual construction or as a matter of economic reality," Mellor-Clark said.

"The majority judgment in the Supreme Court demonstrates the continuing difficulty encountered by the courts in applying economic reality to determine supply relationships. It is abundantly clear that the economic reality is, in practice, far from the objective, singular position which may be suggested by the term. There continues to be a lack of clarity in situations where a business pays for supplies to be delivered to another. What is clear is that the question of to whom a supply is made is not solely determined by signatures on a contract," he said.

The dispute related to a report commissioned from PwC in 2002, when Airtours was in severe financial difficulties. In order for a refinancing of the company’s debts to go ahead, PwC was appointed to report to its lenders on its financial situation. The banks and Airtours signed an engagement letter with PwC, obliging PwC to provide the report to the banks at Airtours' expense. Airtours then tried to recover the VAT it had paid on the fees, which was denied by HM Revenue and Customs (HMRC) on the basis that the supplies were made by PwC to the banks and not to Airtours.

In 2009, the First Tier Tribunal found that Airtours had in fact received supplies from PwC that were used for the purposes of its business, allowing it to deduct the input tax. The VAT rules are designed so that businesses can recover VAT charged in the course of their economic activities as 'input tax' on their own VAT returns. HMRC appealed the First Tier's ruling, and in 2020 the Upper Tribunal found in its favour. The majority of the judges in the Court of Appeal upheld the Upper Tribunal's ruling in 2014.

Both HMRC and the Supreme Court accepted that the services provided by PwC were of "commercial benefit" to Airtours. However, for the purposes of the legislation Airtours had to be able to show that PwC was under a contractual obligation to Airtours to supply those services. The Supreme Court found that it Airtours was unable to do so: the engagement letter stated that it was the banks that had retained PwC and "there was no suggestion that Airtours had done so, or that there was some residual contractual duty to Airtours", Lord Neuberger said.

There were other examples of language in the letter which, while not "logically inconsistent with PwC's contract being with Airtours", were "more consistent with the opposite", the judge said. In addition, the letter "recognise[d] a duty of care on the part of PwC to [the banks], but does not acknowledge one to Airtours", he said.

"As for the fact that Airtours countersigned the letter in the terms that it did, it appears to me that Airtours had to sign in order to be bound by [provisions governing payment of PwC's fees, indemnity and limitation of liability]. In any event, I find it hard to accept the suggestion that the fact that Airtours countersigned, and was required by PwC to countersign, the letter in the terms that it did had the effect of imposing on PwC obligations to Airtours which would not otherwise have arisen from the provisions of the letter," the judge said.

The court then went on to consider whether Airtours' "substantial commercial interest" in the report was sufficient for it to be treated as a 'supply' to the company. Lawyers for Airtours had relied on a speech given by Lord Millet in the 1999 Redrow case, which implied that all was needed was for the taxpayer to have obtained "anything – anything at all - used or to be used for the purposes of his business in return for that payment". However, Lord Neuberger said that this speech could not be "taken at face value".

"From [previous domestic and European judgments], it appears clear that, where the person who pays the supplier is not entitled under the contractual documentation to receive any services from the supplier, then, unless the documentation does not reflect the economic reality, the payer has no right to reclaim by way of input tax the VAT in respect of the payment to the supplier," he said.

"The contract [in this case] did reflect the economic reality, and was not in any way an artificial arrangement. It is true that Airtours benefitted from the contract, but the benefit which it was getting was not so much the services from PwC, but the enhanced possibility of funding from the institutions for its restructuring … And it was to improve the prospects of such refinancing that Airtours was prepared to pay for the provision of the report," he said.

"In deciding the economic reality of the position, it is clear that the Supreme Court wished to contain the impact of Lord Millett's well-known statement in Redrow," said VAT expert Darren Mellor-Clark of Pinsent Masons.

"Businesses analysing the judgment would be well advised to consider careful drafting of contracts, with a full exposition of rights and obligations of the parties in a manner which minimises inconsistent terms. Further, the conduct of the underlying transactions should, clearly, reflect the VAT treatment proposed and the economic reality as the parties understand it to be. In particular, businesses with occupational pension schemes will wish to consider the judgment carefully in light of their potential use of tripartite contracts following the Court of Justice of the EU's judgment in the PPG case in 2013," he said.