VAT composite transactions and sale and leaseback transactions

Update: HMRC confirm approach to "entire interest" disposal. Read our insight here.

The Supreme Court has held that the sale and leaseback of a nursing home entered into by the taxpayer to finance its business did not result in a disposal of the "entire interest" in the property and, accordingly, did not give rise to a taxable self-supply for the purposes of VATA 1994 Schedule 10 para 36: Balhousie Holdings Ltd v HMRC [2021] UKSC 11. The correct interpretation of the "clawback" provision in the scheme for zero-rating supplies used for relevant residential purposes looked to whether the taxpayer still had some substantive right of ownership in the relevant property, not whether it had disposed of its original interest.  

Moreover, in this context, the scheme of VAT did not require the court to treat the two sides of the transaction separately for the purposes of determining the correct construction of the relevant provisions.

Background

The taxpayer, Balhousie, was part of a VAT group which operated care homes. Balhousie originally acquired a care home, Huntly, by way of a zero-rated supply under VATA Sch 8 Group 5, since it qualified as the first grant of a person constructing a building intended for use solely for a relevant residential purpose.

In 2013, Balhousie entered into a sale and leaseback transaction in relation to the Huntly care home to raise funding, in view of difficulties in raising bank funding. The arrangement involved the sale of the property by Balhousie to Target and the immediate leaseback by Target to Balhousie so that Balhousie could continue to operate the care home.

HMRC contended that the result of the sale and leaseback was to trigger the anti-avoidance provisions in Sch 10 paragraphs 35 to 37. These operate inter alia when a person who has received a zero-rated supply subsequently disposes of their "entire interest in the relevant premises". This resulted in a deemed taxable self-supply by Balhousie under paragraph 37. According to HMRC, it did not matter that Balhousie had obtained a lease back since it had, at least for a scintilla temporis, disposed of its entire interest. The First Tier Tribunal rejected this contention, preferring the taxpayer's argument that it was necessary to view the transaction as a composite whole. Viewed as a whole, Balhousie had not disposed of its entire interest, since it still had a leasehold interest in the property. HMRC successfully appealed to the Upper Tribunal arguing that since VAT is a transactional tax, it is not possible to conflate related elements or apply the tax by reference to the composite effect of a number of transactions. The Court of Session upheld the decision of the Upper Tribunal.

Decision of the Supreme Court

The main judgment was delivered by Lord Briggs with whom three other judges agreed.

In essence, Lord Briggs considered that the point at issue was a relatively short point of construction of the UK zero-rating provisions. In this, he dismissed the arguments that these provisions needed to be construed based on EU law principles of construction. That might have been the case had the question been whether the UK provisions were compliant with the EU scheme of VAT, but that was not the case here. The relevant provisions formed "just a small part of a detailed scheme enacted by UK primary legislation, which is compliant with article 110, and which is therefore subject to the usual principles applicable in the UK for the interpretation of statutory material". As such, the question was "whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically".

On this point, Lord Briggs observed that a "reasonably intelligent and well-informed reader of paragraph 36 in its statutory context would be forgiven for thinking it tolerably clear that paragraph 36(2) would trigger a self-supply charge if, but only if, there came a time, during the relevant ten year period, when P no longer had any interest in the relevant premises, including any leasehold interest. If at a particular time P still had a leasehold interest, it could not have disposed of its entire interest. Since the irreducible essence of a sale and leaseback by P is that P ends up at the end of the process (to use a neutral word) with a lease, a sale and leaseback could not trigger a self-supply charge under paragraph 36(2) unless the process was so unwisely structured as to leave a gap in time between the completion of the sale and the taking effect of the leaseback".

Looking to the purpose of the relevant provisions, Lord Briggs considered that to the extent that this could be discerned, 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". There was therefore nothing in this purpose to suggest that a person retaining a substantial leasehold interest following a sale and leaseback should have the benefits of zero-rating withdrawn.

Moreover, Lord Briggs was particularly concerned that HMRC's interpretation would lead to surprising results. For example, a taxpayer acquiring a 21 year lease of a relevant residential building under a zero-rated supply might later buy the freehold, extinguishing the original lease. They might also grant a 21 year lease out of the freehold to a person to operate the business. On these facts, despite the continuing freehold interest, the taxpayer would be treated as having disposed of its "entire interest" on HMRC's case, due to HMRC's focus on the disposal of the interest original acquired by the taxpayer pursuant to the zero-rated supply.

But what of the argument that this approach contravened the very basic requirements that VAT, as a transactional tax, by treating the sale and leaseback as a composite transaction? Lord Briggs had little time for this argument and considered that it no bearing on the question. He pointed out that the only question was whether the taxpayer had disposed of their entire interest. "The question whether a series of transactions may be, or may have to be, looked at in the aggregate depends on the context in which the question arises." In this case, the particular provisions were not concerned with whether there was any particular transaction which amounted to a disposal. "Rather, it demands an enquiry about the existence or otherwise of a state of affairs, namely whether a time came when P (here BCL) no longer had any interest in the relevant premises because it had by then disposed of its entire interest therein."

As a result, the Court considered that, subject possibly to a de minimis exception (which had not been argued and did not arise for decision), "entire" means exactly what it says, namely that the taxpayer no longer has any interest in the premises. That was clearly not the case where, as here, the taxpayer had taken a leaseback as part of the transaction disposing of the freehold.

Judgment of Lady Arden

Lady Arden also agreed that the appeal should be allowed, but differed on two points from the other judges.

Firstly, Lady Arden considered that the jurisprudence of the ECJ indicated that EU principles of construction should be applied to the construction of the UK's domestic zero-rating provisions. This jurisprudence, including comments in the Marks & Spencer decision [2008] STC 1408, "in my judgment makes it clear that the principles of EU law which apply to taxable supplies apply equally to zero-rated supplies

This was important as "it is assumed that P can be said to have disposed of his entire interest in premises as required by paragraph 36(2) of Schedule 10 to VATA if, applying the principles of VAT law, that is the effect of the relevant transaction under which this disposal is said to have occurred. If that key assumption is correct, those principles included the principle, which I will call "the single supply principle", to be derived from Card Protection Plan Ltd".

However, Lady Arden then noted the decision of the ECJ in Mydibel v Belgium (Case C-201/18) [2019] STC 1342. In this case, which involved the adjustment of input VAT on construction costs where a building was subject to a sale and leaseback, the ECJ held that the transaction should, in essence, be combined based on the economic reality of the situation. There was no substantive difference between Mydibel and the current case according to Lady Arden, and accordingly there was no reason why it should not equally be possible to apply single supply analysis in this case to avoid the conclusion that the taxpayer had disposed of its entire interest in the property. For the Mydibel case, see our article "Sale and leaseback treated as a composite transaction for input VAT recovery purposes".

Comment

Quite apart from the specific point in issue concerning the clawback of the benefit of zero-rating, the decision of the Supreme Court is of wider interest to the interpretation of the UK's zero-rating provisions and the importance of EU law in that context. In essence, the majority appear to have considered that normal UK principles of statutory interpretation should be applied unless it is argued that the provisions are in some way contrary to EU law.

In addition, Lady Arden has interpreted the Mydibel decision as extending single supply principles to cases "where the parties were on the opposite sides to each other in the relevant transaction". "Mydibel builds on jurisprudence which is present in Card Protection itself about the need to avoid artificially splitting (or bundling) transactions for VAT purposes." Quite how far this principle can be taken remains to be seen.