SPEED READ: In British Eventing v HMRC, the First Tier Tribunal has confirmed that where an assignee takes on an onerous lease in return for a reverse premium the assignee is making a standard-rated supply on which VAT should be charged. In addition, it was held that the assignment of the onerous lease was not a supply for the purposes of VAT so that the input VAT on the reverse premium was not attributable to it. Instead, it was attributable to the general overheads of the assignor and recoverable in accordance with its partial exemption method.
Taxpayers who incur input VAT on supplies made to them can recover such VAT provided that it is attributable to taxable supplies which they make. Where a taxpayer makes a supply of land it will be an exempt supply unless the taxpayer opts to tax it.
As a result, input VAT cannot be recovered where it is attributable to such exempt supplies. If a taxpayer has made exempt supplies of land permission from HMRC will be required to opt to tax the land and, therefore, charge VAT on future supplies of that land.
In British Eventing v HMRC ([2010] UKFTT 382 (TC)), the appellant occupied a racecourse under a full repairing lease. It initially appointed a manager to run the racecourse on its behalf. However, at a later date it granted a tenancy at will to the manager which commenced operating the racecourse for itself. The rent payable under the tenancy at will was equal to the rent paid by the appellant to its landlord.
No VAT was payable on either rent because neither the appellant nor the appellant’s landlord had opted to tax the land. The appellant sought to assign its lease to its tenant, as a survey revealed that works costing approximately £350,000 to £500,000 were required to reinstate the building in order to comply with the repairing obligations in the lease.
Part of the work that needed to be undertaken was to restore a building that had been fire-damaged for which the appellant had received £140,000 under its insurance policy. Before assigning the lease the appellant sought to opt to tax the land. However, as it had been making prior exempt supplies of the land it required permission from HMRC which was refused.
The appellant assigned its lease to the tenant for £10 and paid it a reverse premium of £340,000 upon which it paid VAT. The appellant sought to recover this input VAT on the basis that it was attributable to the assignment of the lease which should be a taxable supply as HMRC should not have denied permission for it to opt to tax the land.
Jurisdiction of the tribunal
The tribunal considered a number of issues relating to jurisdiction. First, it considered whether it was permitted under VATA 1994 s 80, which places a liability on HMRC to repay overpaid VAT, to direct HMRC to repay to the appellant the VAT it had paid in respect of the reverse premium. The tribunal determined that it had no such jurisdiction since s 80 placed a liability upon HMRC to repay the person who had accounted to them for the VAT.
In the current case, the tenant, rather than the appellant, had accounted to HMRC for the VAT on the reverse premium. However, the tribunal determined that it did have jurisdiction under VATA 1994 s 84 to hear the appellant’s claim against HMRC’s decision that the reverse premium was taxable, since the appellant had a financial interest in the outcome.
Was the reverse premium taxable?
The appellant put forward a number of arguments that the reverse premium was not taxable because it was outside the scope of VAT. First, the payment was either a payment of compensation or it was a dilapidations payment. The tribunal held that it was neither. It was not a compensation payment as it was a payment to the appellant to take on the burden of the lease and restore the property.
It could not be a dilapidations payment as such payments are made to landlords to whom the repairing obligations are owed. Second, the appellant argued that the supply of the assignment and the supply for which the reverse premium was consideration comprised a single economic supply which was exempt since HMRC had refused permission to opt to tax.
The tribunal held that the supplies could not be a single supply since they were made by different persons. Finally the appellant relied upon Mirror Group plc ([2001] STC 1453) which held that a reverse premium paid by a landlord on the grant of a lease was not taxable.
The tribunal distinguished that case as the appellant had assigned rather than granted a lease. It stated that where a reverse premium is paid on the grant of a lease it essentially operates as an adjustment to the rent payable. However, that cannot be the case where there is an assignment, since the landlord is not involved.
The appellant argued that if it was found that the reverse premium was not outside the scope of VAT, it was instead exempt under Lubbock Fine ([1994] STC 101) which held that a reverse premium payable on the surrender of a lease and which involved a change in contractual relationships was not taxable.
The tribunal also distinguished that case stating that Lubbock Fine applied only to a change in contractual relationships on the surrender of a lease, not on an assignment.
The tribunal found that the tenant had made a supply of taking on an onerous lease and agreeing to undertake the building work, which was a taxable supply so that VAT was chargeable on the reverse premium. It stated that the case was 'on all fours' with Cantor Fitzgerald International ([2001] STC 1453) which held that a reverse premium payable on the assignment of a lease was taxable.
To what was the reverse premium attributable?
The tribunal stated that in order to determine whether the reverse premium was attributable to the assignment of the lease it was necessary to determine whether the assignment was a supply for the purposes of VAT. A supply for these purposes is anything done for a consideration, or a deemed supply of business assets under VATA 1994 Sch 4.
The tribunal held that there was no supply for consideration as the payment of £10 for the assignment was nominal and, properly viewed, it should be set off against the reverse premium so that it was a reduction in the consideration paid to the tenant for accepting the lease.
It also found that there could be no deemed supply because the lease was not an asset since the appellant had to pay the tenant to take an assignment of it and it, therefore, had a negative value.
As the assignment was not a supply, the tribunal stated that the reverse premium could not be attributable to it. However, they considered whether it would be so attributable had they been incorrect in determining that the assignment was not a supply.
They found that it could not be, as the input VAT on the reverse premium could not be a cost component of a supply with a much lower value. The tribunal considered the written submissions of HMRC and the appellant as to what the reverse premium was attributable.
It dismissed HMRC’s argument that it was attributable to the past exempt supplies of letting the land, stating that costs consequential to a supply are not cost components of that supply unless it results in the taxpayer’s trade ceasing.
Instead, the tribunal found that the reverse premium was part of the appellant’s general overheads so that it was able to recover the input VAT in accordance with its partial exemption method.
Option to tax
The tribunal did not have jurisdiction to hear an appeal against HMRC’s decision to refuse to grant permission to opt to tax, because the recovery of VAT paid on the reverse premium did not turn on it. Nonetheless, the tribunal considered the issue, and concluded that HMRC was entitled to refuse permission.
VATA 1994 Sch 10 provides that HMRC must have regard to certain considerations when deciding whether to allow a taxpayer to opt to tax. The tribunal concluded that HMRC did not go beyond such considerations by taking into account the disproportionate amount of VAT that the appellant would have been able to recover had permission to opt to tax been granted and had the reverse premium been attributable to the assignment of the lease.
An unsatisfactory decision?
The tribunal’s decision that the reverse premium was taxable was not surprising and confirms the position as set out in Cantor Fitzgerald. Even had there been a grant of a lease, rather than an assignment, as in Mirror Group the reverse premium should have still been taxable as the tenant was doing more than just taking on a lease by agreeing to undertake building works.
It was made clear in Mirror Group that in order for no VAT to be chargeable the tenant must be doing no more than accepting the grant of a lease.
It is less clear that the tribunal was correct in concluding that the lease was not an asset so that the assignment of it was not a supply. While the appellant had to pay the tenant in order to dispose of the lease it still had the ability to utilise the land prior to assignment. The Oxford dictionary of law defines assets as “the total property of a juristic person”.
The lease was the “property” of the appellant despite having a negative value. If the tribunal’s interpretation is correct a person could have an asset one day but due to external factors it may not be an asset the following day.
The determination of whether something is an asset could, as a result, depend upon the valuation received, with one valuation deeming it to be an asset and the other not.
It is also doubtful that it was correct for the tribunal to conclude that the input VAT paid on a supply received cannot be a cost component of a supply made if it exceeds the value of that supply, thereby restricting input VAT recovery. The application of such a decision could result in taxpayers being denied input VAT recovery where they charge less output VAT due to a declining market.
The tribunal appeared to be striving to reach a compromise by allowing the appellant to recover part of its input VAT. However, in so doing they have reached an unsatisfactory decision that property with a negative value cannot be an asset, with the result that those persons with a wholly or partially exempt business will have their recoverable input VAT restricted.
John Challoner is a Corporate Tax Partner at Norton Rose LLP. He specialises in collective investment schemes, property funds, developments and investment, Islamic finance, corporate restructurings, mergers and acquisitions, domestic and international joint ventures and VAT. Email: john.challoner@nortonrose.com; tel: 020 7444 3389.
Kristy Cooper is a Tax Associate at Norton Rose LLP. She also specialises in collective investment schemes, property funds, developments and investment, corporate restructurings and mergers and acquisitions. Email: kristy.cooper@nortonrose.com; tel: 020 7444 2118.
