“ 12. The ordinary meaning of the expression and its function in the context of the provisions of the Second Directive indicate that it covers goods used for the purposes of some business activity and distinguishable by their durable nature and their value and such that the acquisition costs are not normally treated as current expenditure but written off over several years. ” 51. In Régie Dauphinoise the trader operated a property management business. In the course of that business it received advances from owners and lessees which it was entitled to invest and retain the interest. The tax authority regarded the interest as exempt income that should be included in the denominator for the partial exemption calculation. The trader maintained that the sums should be excluded under Article 19(2) as “incidental transactions”. 52. The ECJ held that the interest was not an incidental transaction and therefore not to be excluded from the calculation of deductible input tax. At [21] and [22] it stated: “ 21. The purpose of excluding incidental financial transactions from the denominator of the fraction used to calculate the deductible proportion in accordance with Article 19 of the Sixth Directive is to comply with the objective of complete neutrality guaranteed by the common system of VAT. As the Advocate General has observed at point 39 of his Opinion, if all receipts from a taxable person' s financial transactions linked to a taxable activity were to be included in that denominator, even where the creation of such receipts did not entail the use of goods or services subject to VAT or, at least, entailed only their very limited use, calculation of the deduction would be distorted. 22. However, placements by property management companies are the consequence of advances to them by co-owners and lessees for whom they manage their properties. With the consent of their clients, those companies are able to place these monies for their own account with financial institutions. That is why, as the Court has pointed out at paragraph 18 of this judgment, the receipt of interest from those placements constitutes the direct, permanent and necessary extension of the taxable activity of property management companies. Such placements cannot therefore be characterized as incidental financial transactions within the meaning of Article 19(2) of the Sixth Directive. To take them into account in order to calculate the deductible proportion would not be such as to affect the neutrality of the system of value added tax. ”
“ 61. …although under the criteria set out by the court in [Verbond], vehicles purchased by an undertaking in order to carry on its economic activities may be capital goods within the meaning of art 19 of the Sixth Directive, it cannot be inferred from those criteria that such vehicles are to be so categorised if the sale thereof at the end of the leasing contracts forms an integral part of the taxable person’s regular activity . That is why I take the view that the interpretation of the concept of capital goods given by the court in the [Verbond] judgment does not enable an answer to be given to the question referred … ” 62. The Court found that the interpretation of capital goods in Verbond was not relevant for the purpose of answering the question referred. At [29] it stated: “ 29. To exclude generally from the calculation of the deductible proportion goods which are used for the purposes of a business activity and are indeed distinguishable by their durable nature and their value, such that the acquisition costs are not normally treated as current expenditure but are written off over several years, without taking account of the fact that the sale of those goods, at the end of the leasing contracts, is an integral part of the normal activity of the taxable person , would run directly counter to the objective of neutrality of the common system of VAT. … 31. The interpretation given by the Court in [Verbond] is not therefore relevant for the purpose of answering the question referred for a preliminary ruling in the present case. ”
“ 35. …the sale, in the case of a building business, of buildings constructed on its own account cannot be classified as an 'incidental real estate transaction' within the meaning of that provision, where that activity constitutes the direct, permanent and necessary extension of its business. In those circumstances, it is not necessary, in this case, to assess to what extent that sales activity, viewed separately, entails a use of goods and services on which VAT is payable. ” 67. The third question in NCC was whether it was consistent with the principle of fiscal neutrality for a building business, which is required to pay VAT on self supplies, not to be able to fully deduct the VAT relating to the general costs incurred thereby because the turnover from the sale of such buildings was exempt from VAT. 68. The Court held that the result was consistent with fiscal neutrality. At [44] it stated that the principle of fiscal neutrality required “ that different types of economic operators in comparable situations be treated in the same way in order to avoid any distortion of competition within the internal market… ”
“… the starting point for determining the question of whether demonstrator cars are capital goods is to identify whether they are goods the use and sale of which consumes input tax in the same way as the Appellant’s stock of new and used cars. At the heart of this question will be to determine whether for the whole of the period of ownership the demonstrator cars were to be resold (that being the nature of the normal activities of the Appellant’s business) or whether they were for use within the business and by the business by way of its own consumption (even when after use as a demonstrator they are then sold)”. 81. For the reasons given above we do not consider that the issue is simply whether or not the asset in question uses inputs in a way not proportionate to its eventual sales value. That is not the starting point. It seems to us that the starting point is identifying whether the Demonstrators are capital goods having regard to the meaning given to that term in the authorities in the context in which it is used, namely Article 19(2). 82. Ms Brown submitted that the Sixth Directive provided two mechanisms to ensure the neutrality of the deduction system where turnover does not represent an appropriate proxy for the use of mixed use inputs. Firstly Article 19(2) expressly removes from the calculation two types of turnover where the assumed proxy does not hold true in the form of capital goods and certain incidental transactions. Secondly where a turnover calculation does not result in an appropriate proxy for use, Member States can adopt an alternative solution based on use. In our view those methods are only alternatives in the sense that in the end only one method will be used. More broadly, they are both part of the same mechanism which is designed to fairly apportion mixed use input tax between taxable supplies and exempt supplies. 83. We accept Mr Puzey’s submission that the starting point is that a turnover based calculation will be employed and turnover in relation to capital goods will be excluded. At that stage consideration must be given to whether the Demonstrators are capital goods. If they are not, but the turnover based calculation does not produce a fair and reasonable apportionment then a special method may be employed. Detailed comparative analysis of use is reserved to the next stage which in this appeal is the issue of quantum. 84. The UK domestic legislation in what is now regulation 102 makes provision for special methods of input tax apportionment to be used. Regulation 102 excludes from any special method “the value of a supply” of capital goods. It is easy to see that including capital goods in a turnover based calculation would tend to distort input tax recovery and therefore fiscal neutrality. It is less easy to see why capital goods should not be included in a use based special method where they do use mixed use inputs. It is notable that regulation 102 refers to excluding the “value” attributable to capital goods from the calculation. Whether anything turns on that was not the subject of submissions. In any event the point remains that if the Demonstrators do not use inputs in the same way as new cars purchased for sale then if they are not capital goods a special method can be used to apportion input tax to them. The appropriate proxy for use of inputs by the Demonstrators if they are not capital goods would be a matter to be considered in determining quantum pursuant to the second ground of appeal. 85. We turn now to consider whether the Demonstrators were capital goods for the purposes of Article 19(2) on the facts as found. 86. The Demonstrators were purchased for use in the business with a view to selling them as used cars. The point was not specifically covered in Mr Smith’s evidence but we infer that the reasons for seeking to keep the mileage of Demonstrators as low as possible include ensuring that the Demonstrator has the appearance and feel of a new vehicle as well as maximising the value of the vehicle on resale. The Demonstrators were actually used for relatively short periods of time prior to sale. 87. The Appellant was in business selling both new and used vehicles. As such, the Demonstrators were goods of the same type and value as those sold in the ordinary course of the Appellant’s trading activities. 88. There is no evidence as to how the Demonstrators were treated for accounting purposes, in particular whether they were treated as fixed assets and depreciated in the management accounts. We accept that the economic circumstances in the period 1973 to 1987 involved periods of generally high inflation and the need to depreciate in the management accounts may not have existed. We therefore attach no significance to the absence of such evidence. 89. We do not accept on the facts that there is a complete disconnect between use of mixed use overheads and turnover from the sale of Demonstrators. The Demonstrators occupied space on the premises and sales transactions would require processing in exactly the same way as a new or used car being sold by the Appellant. We are not satisfied that mixed use inputs are not used at all in making sales of Demonstrators. . 90. The fact that 70% of Demonstrators were sold without marketing would reduce the extent to which sales of Demonstrators used inputs. However in our view that is not a very significant factor in determining whether they are capital goods. 91. The regularity with which Demonstrators were bought and sold at two to six month intervals is an indicator that such sales are part of the Appellant’s normal trading activity. 92. Ms Brown submitted that the very reason input tax had been blocked on the purchase of Demonstrators was because they were not purchased for the purpose of being sold. As such Demonstrators clearly had a different character to cars purchased for resale as new. The cost of running the Demonstrators was a cost component of the taxable supplies made by the Appellant. 93. We accept that Demonstrators were different in character to new car purchased for sale, but only to the extent that they were used in the business for a short period of time prior to sale. We do not consider that the existence of the input tax block means that the Demonstrators were sold otherwise than as an integral part of the Appellant’s normal activities or that the transactions are otherwise unusual. 94. In the light of all the evidence we are satisfied that the purchase and sale of a Demonstrator is just as much a part of the trading activity of the Appellant as the purchase and sale of new and used cars. Sales of Demonstrators are integral to that activity. It would be distortive to exclude such turnover from the partial exemption calculation, although we accept that a special method might be required to properly reflect the use those sales make of inputs. In our view fiscal neutrality is maintained because it will still be necessary to identify the extent to which sales of the Demonstrators use the mixed use inputs. 95. Mr Puzey invited us to find that the sale of Demonstrators was a direct, permanent and necessary extension of the taxable activity of selling new cars. We do so, but recognising that this formulation is relevant in the context of incidental transactions and it does not appear to be relevant in the context of capital goods. 96. In relation to the second aspect of fiscal neutrality, Ms Brown submitted that all taxpayers subject to the input tax block should be treated equally. HMRC’s assessment in the present case had the effect that motor traders were treated differently to other businesses subject to the input tax block. In her words they were subject to “an additional restriction on their recovery of input tax over and above non motor traders purely because of the nature of their business”