Sale and leaseback treated as a composite transaction

Update

The Supreme Court has now overturned the decision in Balhousie and held that a person that entered into a sale and leaseback transaction did not dispose of their entire interest in the relevant residential property so as to give rise to a deemed taxable supply, see “VAT composite transactions and sale and leaseback transactions”.

The European Court of Justice (ECJ) has indicated that a sale a leaseback transaction may be regarded as a single transaction for the purposes of determining whether a person has disposed of property in the context of the operation of the capital goods scheme: Mydibel SA v Belgium (Case C201/18) (ECJ, 27 March 2019). The decision stands in sharp contrast to the recent decision of the Court of Session in Balhousie.

The Court has endorsed an approach, in this context at least, which recognises the composite nature of a transaction and applies the input VAT rules to that composite transaction, ignoring individual elements. How far this principle may extend is a matter of conjecture.

Background

The case involved a Belgian business that owned several buildings which it used in its economic activity of producing potato based products. Mydibel had initially recovered all of the VAT it had incurred in relation to those buildings used in its taxable business. In 2009, in order to increase its liquidity, Mydibel entered into sale and leaseback transactions over its buildings. Those transactions were exempt from VAT. The sale and leaseback arrangements involved the creation of “emphyteutic rights” in favour of financial institutions, giving those institutions rights for 99 years in return for the immediate payment of “emphyteutic” rent in excess of €10m. In addition, it entered into a leaseback of the properties for a period of 15 years in return for the payment of quarterly rent to the financial institutions in an amount corresponding to “an investment value” equal to the amounts received under the sale plus interest.

Following these transactions, the Belgian tax authorities sought to adjust Mydibel’s initial VAT deduction on the buildings on the basis that Mydibel had used them to make an exempt supply (the initial exempt sale of the buildings under the sale and leaseback). On appeal, the Belgian courts referred the matter to the ECJ.

Decision of the ECJ

The ECJ has considered the issue of adjustment of the original deduction both from the perspective of an adjustment under Articles 184 and 185 of the Principal VAT Directive and under the provisions relating to the capital goods scheme (Articles 187 and 188).

Articles 184 and 185 apply an adjustment of the initial deduction of VAT where some change occurs in the factors used to determine the amount to be deducted. However, in this case, there was no such change. The buildings were originally intended to be used for the purposes of the business and they continued to be so used, even after the sale and leaseback. The Court rejected the European Commission’s argument that the creation of the ”emphyteutic right not subject to VAT” should be regarded as a change in the factors used to determine input VAT deduction. The creation of that right did not have the effect of breaking “the close and direct relationship between the right to deduct input VAT and the use of the goods or services concerned for taxable output transactions”.

As regards the operation of the capital goods scheme, the Court noted that where the relevant capital goods are supplied during the period of adjustment, they are to be treated as if they used for the remainder of the capital goods period by the taxpayer for a business that is taxable (if the supply of the goods was taxable) or exempt (if the supply of the goods was exempt). Here, the Belgian tax authorities relied on the fact that Mydibel had made an exempt supply of the buildings and so required an adjustment of input VAT under the capital goods scheme on the basis that Mydibel should be deemed to have used the goods for the purposes of exempt activities for the remainder of the period.

The ECJ has rejected that argument. In particular, the Court emphasised that it was necessary to determine whether “the grant of the emphyteutic right and of the leasing of real property must be considered separately or together”. The Court then referred to its “single supply” case law involving elements that are so closely linked that they form, objectively, a single, indivisible economic supply, which it would be artificial to split. Whilst it was for the national court to determine whether the particular situation had the characteristics of a “single transaction”, the Court nevertheless provided a strong steer that it did. The Court stressed that the sale and leaseback was to increase the taxpayer’s liquidity and the buildings remained in the possession of the taxpayer, which used them for in an uninterrupted manner. Those factors appeared to indicate that they formed part of a single transaction. If there was a “single transaction”, then the Court stated that it could not be classified as a “supply of goods” for the purposes of Article 188. The Court pointed out that a “supply of goods” requires a transfer of property to a party which empowers that person to dispose of it as owner. However, when seen as a single transaction, the civil law rights of the financial institutions reduced by the leases back to Mydibel did not empower them to dispose of the buildings as if they were the owners.

Comment

The contrast between the decision of the ECJ in this case and the Court of Session in the recent Balhousie case is striking. In Balhousie, the Court of Session rejected the application of a “composite” approach to linked transactions based on the application of fundamental VAT principles (the need to apply VAT to each transaction separately). However, the ECJ, with very little analysis, has taken quite a different approach, suggesting that the sale element of a sale and leaseback can be ignored (at least for certain purposes) when analysing the VAT consequences.

Moreover, the Court suggested that this was possible by reference to its single supply case law. The single supply case law normally applies where there is more than one supply or more than one element to a supply by the same person. However, in this case the ECJ has applied these principles to linked supplies by separate taxable persons - again with no real analysis.

The decision in this case - relating to the adjustment of input VAT - relates to a different situation to that in Balhousie, which involved the application of anti-avoidance legislation in relation to zero-rated supplies. Nevertheless, it clearly calls into question that decision and the rejection by the Court of Session of a composite transaction approach.

More generally, the decision, by suggesting that there are circumstances that a combined transaction may be treated as a composite one for VAT purposes, may well open up wider arguments in this context. The Court may well find it itself having to determine whether this new principle that it has unveiled is limited to input VAT adjustments or can be applied in a wider set of circumstances.