UK Supreme Court: sale and leaseback did not trigger VAT clawback

Property tax expert Andrew McCarthy of Pinsent Masons, the law firm behind Out-Law, said: "It is clearly the right decision from the Supreme Court that the change of use rules should not be triggered where the actual use of a property remains the same and only the legal interest in the property changes".

"HMRC were taking an overly mechanistic approach at odds with the intention of the zero-rating legislation," he said.

The first grant of a major interest in a building by a person constructing or converting it for use for a relevant residential or charitable purpose is zero rated for VAT purposes, which means that VAT is not charged. A “relevant residential purpose” includes use as a house or as a care home.

However, the benefit of the zero rating is clawed-back if within ten years from the completion of the building the purchaser disposes of its "entire interest" in the building or changes the use of the building from a qualifying to a non-qualifying use. Either of those events happening triggers a 'self-supply' charge to VAT, payable by the purchaser.

In a case involving a company called Balhousie Care Ltd (BCL) which had acquired a recently constructed care home in Scotland under a zero-rated first grant from the developer and then financed that acquisition by a sale and leaseback of the building with a finance house, HMRC argued that the sale and leaseback constituted a disposal by the company of its entire interest in the care home, so as to trigger a VAT self-supply charge on BCL.

HMRC argued that the self-supply was triggered because BCL had sold the interest which it acquired by the zero-rated first grant from the developer and it was not relevant that by virtue of the leaseback it continued to hold a major interest in the property.

Delivering the majority judgment, Lord Briggs quoted a Hong Kong Final Court of Appeal case involving a company called Arrowtown Assets Ltd, where Judge Ribeiro said: "The ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically".

He said this principle of statutory construction "is of general effect"; does not only apply in relation to tax avoidance; and applies to VAT as well as taxes on income or gains.

Lord Briggs said that the purpose of the relevant clawback provision was not, as HMRC had argued, to ensure the purchaser (P) retained sufficient control to prevent a change of use. "Rather it is concerned with avoiding conferring the large tax benefit of zero-rating upon a person who is not prepared to commit to the project of creating and operating a building for a specified socially desirable residential use for a substantial period of time after its completion," he said.

"The bar is set very low, by setting the trigger for claw-back at the point when P has disposed of P's entire interest, rather than some lesser proportion of it. Subject possibly to a de minimis exception, which has not been argued and does not arise for decision, 'entire' means exactly what it says, namely that P no longer has any interest in the premises," the judge said.

Lord Briggs said that the sale and the lease were two simultaneous transactions each of which was a transfer of a major interest and there was no moment when BCL had neither of them so that the claw-back provisions did not apply.

He also said that the state of affairs which triggers the claw-back could come about by a single transaction disposing of the entirety of the interest, by two or more simultaneous transactions disposing together of the entirety, or by a series of successive transactions following the last of which the entirety had been disposed of. In such cases all relevant transactions may need to be considered, so that the aggregate of their combined effect can be assessed.

Lord Briggs said that EU law principles as to whether or not the sale and leaseback constituted two separate transactions or a single transaction were not relevant. Lady Arden thought that EU law principles were relevant, but on the basis of the CJEU's decision in the case of Mydibel she said that the sale and leaseback should be treated as a single transaction so that BCL did not dispose of its entire interest.

HMRC's argument that it was only the interest which BCL had acquired from the developer which was relevant "simply fails to make sense of [the clawback provision], whatever rational purpose may be assigned to it", Lord Briggs said in his judgment.

"Whilst this decision settles the position for the zero rating change of use charge, it may have further applications for other VAT provisions," said Richard Croker, a property tax expert at Pinsent Masons.

"It could be relevant for the treatment of capital goods scheme disposals. However, there is probably no support in the judgment for the argument that a sale and leaseback is a single supply and not a barter transaction," he said.