VAT on theatrical production costs not linked to catering sales

Royal Opera House’s claim

ROH submitted a retrospective claim for under-recovered VAT on production costs on the basis that its catering and bar income should be included in the partial exemption calculation, because the correct test was to consider the business activities of the organisation as a whole, and the ‘economic use’ of the costs. This was based on the Chester Zoo FTT case, where the zoo had successfully argued that its catering income should be included in the partial exemption calculation, which HMRC didn’t appeal.

ROH argued that the staging of its operas increased the sale of bar and catering income by attracting customers, and this income in turn ultimately funded part of the cost of productions. ROH were suggesting that the production costs were incurred to attract customers to both types of supply – the exempt ticket sales and the taxable bar/catering services, which together formed “a fully integrated visitor experience”. ROH therefore argued that there was a direct and immediate link between production costs and bar and catering income, and thus this income could be used in calculations to determine the percentage of VAT recovery. This was accepted by the First Tier Tribunal (FTT), but HMRC then appealed to the Upper Tribunal (UT) which confirmed HMRC’s view. The UT concluded that the production costs only had a direct and immediate link with the exempt supply of tickets (and other production-related taxable supplies), not the catering and bar income. The production costs were not ‘cost components’ of the catering supplies. ROH were given leave to appeal to the Court of Appeal.

The Court of Appeal (CA) decision

In a unanimous decision, the Court ruled in favour of HMRC. The judges considered case precedents and concluded there was no “direct and immediate link” between the expenditure on production costs and the income arising from catering, bar and souvenir sales. They commented that customers would not normally eat or drink at the opera house unless they were there to see the performance; and many customers would only see the performance and would not eat or drink. 

What does this mean?

The decision was not unexpected and an appeal to the Supreme Court looks unlikely. Most exempt theatres can deduct a proportion of VAT on production costs, as HMRC accept there are some taxable supplies that are directly linked (such as programme sales), as mentioned above. However, the CA decision confirms that the FTT decision in the Chester Zoo case can no longer provide support for similar culturally exempt businesses to boost their input tax recovery on production/exhibition costs by including catering and retail income in their partial exemption calculations. This case also has wider implications for any partly exempt business seeking to use the “economic use” argument for deduction of VAT. 

There are also some organisations where the level of input tax incurred on productions/exhibitions is low enough not to trigger the ‘substantial’ test; these entities will not be affected by this decision. Generally, the difference in input tax between the standard method and another method needs to be more than £50,000 before HMRC can trigger these provisions. 

Otherwise, this case is another blow for the cultural sector in this most difficult period.

What should you do?

If you’re operating under the cultural exemption and have been including catering bar or retail income in your partial exemption calculations for exhibitions or productions, we recommend that you now review your input tax deduction in the light of this case.

For more information on the implications of this case or to speak directly with one of our experts about the deduction of VAT on costs, please fill out the form below and we will be in touch.