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Marketing costs found to relate to exempt products

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This tribunal case considered whether marketing can be treated as a general overhead if it advertises a specific product but leads to cross-selling of others.

3rd Jan 2024
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KRS Finance Ltd was part of a VAT group that also contained Key Retirement Solutions Ltd (Solutions), More 2 Life Ltd and KRS Services Ltd.

The group generated its income through various streams, including providing advice on equity release mortgages (ERM) and estate planning (EP) via Solutions, with the ERM income being almost entirely exempt and the EP income standard rated for VAT purposes. It also received income from solicitors in connection with ERM advice.

The group was therefore partially exempt and had previously used the standard method to calculate its VAT recovery each quarter, before engaging KPMG to advise on an alternative recovery basis.

HMRC disagreements

KPMG proposed a special method to HMRC, which was rejected. A further method was proposed, using a similar basis to the first, but this time on an adjusted income basis. This was again rejected.

While waiting for HMRC to respond to the above proposals, the group had also submitted four error correction notices (ECNs), applying the special method(s) to earlier quarters. As HMRC subsequently rejected the proposed methods, these ECNs were similarly rejected.

Finally, HMRC carried out a review of the group’s marketing expenditure and concluded that part of the VAT incurred on advertising was directly attributable to the ERM income and so assessed for over-recovered VAT.

The group appealed to the first tier tribunal (FTT) against the rejected special methods, the refused ECNs and the allocation of the marketing costs.

Marketing expenditure

The group’s stance was that the marketing expenditure was incurred to generate income for Solutions generally and so should be categorised as overheads. It argued that customers who contacted Solutions then went on to purchase ERM and/or EP products. The marketing therefore was incurred to get the customer to make contact, from which all income streams became available.

Alternatively, the group argued that there was a sufficient and direct link to both the EP income and the solicitor referral fees (SRF), which were received when the group passed on work to solicitors. Both of these streams were standard rated.

The FTT believed this part of the appeal could be resolved by first considering whether the marketing expenditure had a direct and immediate link to the ERM, EP or SRF income, or indeed all three. Should this be the case, there would be no need to consider whether a direct and immediate link existed with the economic activity in general.

Direct and immediate link?

It was clear that some of the advertising costs incurred by Solutions had a general intended outcome, such as raising overall brand awareness. However, the marketing activities in question were focused on Solutions’ self-proclaimed “hero product” – a product that is comparatively easy to market and which helps establish the business brand.

Solutions’ hero product was clearly ERM, which was used to create an initial interest and enable the other products to be sold. While it was possible for a customer to buy only the EP product, the initial appointment would always have been booked based on the ERM product, as the advertising in question did not refer to EP products at all.

The FTT concluded that there was a direct and immediate link between the contested marketing costs and the ERM products. Further, no such direct and immediate link could be established between the costs and the EP products, nor the SRF income.

The marketing income appeal was therefore dismissed.

Apportionment of input tax

Where a business has both exempt and taxable income it is required to apportion its input tax between recoverable and irrecoverable pots.

While many businesses use the standard method, they can instead apply to HMRC for permission to use a special method, provided that this would produce a fairer and more reasonable attribution of input tax. HMRC can agree or refuse this special method and may later alter the method if it ceases to be fair and reasonable.

In this case, HMRC had refused two special method proposals, each based on a similar starting point. The FTT ultimately agreed that this was a reasonable decision, as each method was based on flawed logic and, in light of the marketing decision above, did not correctly attribute the marketing costs to exempt income.

The group was unable to convince the FTT that either special method gave a fairer outcome than the standard method, therefore the FTT dismissed their appeals, including the ECN appeal, which had been contingent on one of the special methods being accepted.

Appeals dismissed

The group’s appeals were therefore dismissed in full.

For a similar case, see the joint SL and DFS FTT decision, which also focused on direct and immediate links of supplies to marketing costs.

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