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The inside of a recording studio
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VAT: Business failure no bar to input tax claim

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1st Feb 2017
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Neil Warren reviews a case concerning a record company which built a recording studio, but never used it, and reclaimed input tax on the costs.

Overture

Gravel Road Records Ltd (TC5598) registered for VAT in May 2009, with an intention to construct a recording studio and hire it out to commercial users for a daily fee of between £500 and £700. No sales were ever made, and HMRC cancelled the VAT registration in June 2014, backdating it to May 2009, on the basis that there had never been an intention to make taxable supplies. All the input tax claimed in the period of registration was therefore disallowed. Were HMRC correct to disallow this input tax?

Principle facts

The director (Mr Townsend) owned 35% of the company shares, supported by two external investors: Icealarm Ltd (60%) and Mr Robinson (5%). The latter was also the company secretary.

The taxpayer claimed the external investors would never have become involved if there had not been a commercial intention. He also highlighted builder problems with the construction process, which led to delays in completion and two key potential customers seeking alternative studios. The music industry had encountered difficult times in 2010 onwards, when many potential clients “went to the wall”. Icealarm refused to provide further funding after 2012 and Gravel Road Records Ltd therefore forfeited its lease on the premises and ceased to trade.

HMRC’s argument

HMRC applied the six business tests identified in the landmark 1981 case of C&E Commissioners v Lord Fisher (STC 238) to conclude that the company never had any intention to trade. Their conclusion was that the project was a private pursuit of the director rather than a serious business, and they disallowed all input tax claimed on VAT returns submitted since 2009.

However, Townsend highlighted that a “hobby” rather than “business” venture would normally be undertaken at the residential address of a director (rather than in commercial premises), and using a studio that was a lot cheaper and less specialised than the one that the company had constructed.

Court findings

The court agreed with the taxpayer and allowed the appeal. The judge concluded:

“We think that his evidence was persuasive that the scale of investment in the construction and equipping of the recording studio in leased industrial premises points to an intention to pursue a commercial business activity. The construction and equipping of this recording studio does not appear to us to be a ‘hobby’ activity. It was financed almost entirely by a third party, Icealarm Limited, and there was nothing to contradict Mr Townsend’s evidence that Icealarm was investing in a recording studio that was intended and designed (and had at the outset the potential) to repay its investment and to make a commercial return for it on that investment.”

Finale

I find it surprising that HMRC challenged the company’s business intentions when there was a third party investor involved. That investor clearly had no interest in music, and only wanted to make a profit on its investment. It seemed that the director had high hopes of creating a successful business, but the delivery of the project was not as good as the original idea. As far as input tax recovery was concerned, the original intention was important rather than the end result.

This case is a useful reference for tax advisers to quote in situations where HMRC challenge input tax claims on the costs of either abortive or loss making projects.

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