In Sofology Ltd and another v HMRC [2022] UKFTT 153 (TC) (29 April 2022), the FTT decided that online advertising costs could be recovered in full, on the basis that these costs had a direct and immediate link to the sale of sofas and did not relate to exempt insurance commissions.
In 2009, the FTT ruled that advertising costs incurred by sofa retailer DFS were directly attributable to its taxable supplies of sofas and not to its exempt supplies of insurance intermediary services. DFS was therefore entitled to recover the input tax relating to all the advertising costs. In that case, the advertising was through traditional media (TV, posters, booklets and direct mailing). The insurance intermediary services in question related to sales of Sofashield or Sofacare insurance to protect against accidental stains and scratches to the new sofas purchased by customers. DFS earnt exempt insurance commission for arranging these policies.
Not surprisingly, DFS and its competitor, Sofology, applied the same approach when adopting more modern forms of advertising, specifically PPC (pay per click) advertising via google. Under a PPC model, retailers like Sofology and DFS agree to pay Google each time a customer clicks on one of the promoted, sponsored links. However, HMRC challenged this approach, arguing that the online advertising costs had a direct and immediate link to both the taxable sale of sofas and the exempt insurance commissions or, in the alternative, that the costs should be treated as an overhead. In either case, HMRC considered an apportionment of the input tax would be required.
In a detailed decision, the FTT found for the taxpayers, holding that there was only an indirect link between the online advertising and the supply of insurance intermediary services. Objectively, the taxpayers incurred the Google costs to promote the sales of sofas. Whilst the promoted results for the sofas might lead to sales of associated insurance, and DFS/Sofology would see this as a positive outcome (as the insurance commissions were profitable), the fact that there was an economic link, or a close link, between the sofas and the insurance did not mean that a direct and immediate link existed between the advertising costs and the insurance intermediary services. Instead, the advertising costs were directly attributable to the taxable sales of sofas only.
In response to HMRC’s secondary argument that the costs should be treated as an overhead, the FTT noted that the allocation of the costs to the category of ‘overheads’ ‘is a last resort to be adopted only if it is not possible to identify a supply or supplies with which the relevant costs have a direct and immediate link’. Given that the FTT considered there to be a direct and immediate link between the advertising costs and the sale of sofas, the FTT dismissed HMRC’s argument that the advertising costs should be treated as an overhead of the business.
Why it matters: The decision breaks no new legal ground and is heavily fact-dependent but is useful in showing how the established approach to advertising costs applies to the virtual world. It is also worth noting that although there was a positive outcome in this decision for the taxpayers, it does demonstrate that it is not possible to apply earlier decisions or HMRC rulings to evolving fact patterns without properly analysing the facts.
In Sofology Ltd and another v HMRC [2022] UKFTT 153 (TC) (29 April 2022), the FTT decided that online advertising costs could be recovered in full, on the basis that these costs had a direct and immediate link to the sale of sofas and did not relate to exempt insurance commissions.
In 2009, the FTT ruled that advertising costs incurred by sofa retailer DFS were directly attributable to its taxable supplies of sofas and not to its exempt supplies of insurance intermediary services. DFS was therefore entitled to recover the input tax relating to all the advertising costs. In that case, the advertising was through traditional media (TV, posters, booklets and direct mailing). The insurance intermediary services in question related to sales of Sofashield or Sofacare insurance to protect against accidental stains and scratches to the new sofas purchased by customers. DFS earnt exempt insurance commission for arranging these policies.
Not surprisingly, DFS and its competitor, Sofology, applied the same approach when adopting more modern forms of advertising, specifically PPC (pay per click) advertising via google. Under a PPC model, retailers like Sofology and DFS agree to pay Google each time a customer clicks on one of the promoted, sponsored links. However, HMRC challenged this approach, arguing that the online advertising costs had a direct and immediate link to both the taxable sale of sofas and the exempt insurance commissions or, in the alternative, that the costs should be treated as an overhead. In either case, HMRC considered an apportionment of the input tax would be required.
In a detailed decision, the FTT found for the taxpayers, holding that there was only an indirect link between the online advertising and the supply of insurance intermediary services. Objectively, the taxpayers incurred the Google costs to promote the sales of sofas. Whilst the promoted results for the sofas might lead to sales of associated insurance, and DFS/Sofology would see this as a positive outcome (as the insurance commissions were profitable), the fact that there was an economic link, or a close link, between the sofas and the insurance did not mean that a direct and immediate link existed between the advertising costs and the insurance intermediary services. Instead, the advertising costs were directly attributable to the taxable sales of sofas only.
In response to HMRC’s secondary argument that the costs should be treated as an overhead, the FTT noted that the allocation of the costs to the category of ‘overheads’ ‘is a last resort to be adopted only if it is not possible to identify a supply or supplies with which the relevant costs have a direct and immediate link’. Given that the FTT considered there to be a direct and immediate link between the advertising costs and the sale of sofas, the FTT dismissed HMRC’s argument that the advertising costs should be treated as an overhead of the business.
Why it matters: The decision breaks no new legal ground and is heavily fact-dependent but is useful in showing how the established approach to advertising costs applies to the virtual world. It is also worth noting that although there was a positive outcome in this decision for the taxpayers, it does demonstrate that it is not possible to apply earlier decisions or HMRC rulings to evolving fact patterns without properly analysing the facts.
