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The VAT briefing for September 2013

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Key developments since last month’s briefing are as follows. In Hilden Park Partnership, the FTT recharacterised supplies made pursuant to an abusive scheme as being made by the persons who in practice gained the tax advantage rather than the original suppliers (who were insolvent). In Davis & Dann, the UT confirmed that a taxpayer should have known that a transaction was connected to fraud if the only reasonable explanation for the transaction was that it was so connected. In University of Huddersfield, the FTT held that the Halifax principle only applies when arrangements result in an absolute saving of VAT, and not when they simply defer VAT payment. In Palatial Leisure, the FTT confirmed that, for the purposes of attributing input VAT, it is necessary to ascertain the use of goods at the time when the input VAT becomes chargeable.

Hilden Park: abuse of law

In Julian Massey t/a Hilden Park Partnership v HMRC [2013] UKFTT 391 (TC), the First-tier Tribunal (FTT) redefined supplies made pursuant to an abusive scheme as being made by the persons who in practice gained the tax advantage rather than the original suppliers.

An existing golf course business was transferred from a partnership to two companies limited by guarantee, with the aim of benefiting from the exemption for non-profit providers of sports and physical education. The original transferor extracted a profit from the companies by taking payments of rent and various fees. The arrangements were made pursuant to an established avoidance scheme. The scheme, while not inherently abusive, led to a tax advantage considered by the FTT to be abusive in this case, owing to the excessive rent and other uncommercial terms used to facilitate covert profit extraction from the companies. These factors also showed that the companies were not entitled to the exemption claimed. Despite the failure of the scheme, the FTT used the doctrine of abuse from Halifax (C-255/02) to attribute the supplies to the transferor, necessitated by the fact that the taxpayers were in liquidation and could not meet the VAT liability.

Why it matters

Where an avoidance scheme is found to be otherwise effective as a matter of law, the ability to recharacterise the situation on the authority of Halifax may serve as a last resort for HMRC. In this case, the scheme, as intended by the taxpayer, failed as a matter of law. However, the value of Halifax to HMRC in this case was that, following the decision in Atrium Club Ltd [2010] STC 1493, it allowed recovery of unpaid VAT, even though the taxpayer had entered liquidation. Recovery was instead possible by reattributing the supplies to the person to whom the tax advantage had accrued in practice (the transferor partnership in this case), albeit indirectly in the form of rent and fees rather than an unpaid tax liability.

Also of interest are the FTT’s comments on the burden of proof and pre-packaged schemes. The FTT confirmed that the burden of proof does not shift to HMRC in Halifax cases; the appellant must raise a prima facie case that what it did was not abusive and then the evidential burden shifts to HMRC to show otherwise. The FTT declined to take into account the fact the scheme was pre-packaged in finding that the essential aim was obtaining an abusive tax advantage, noting that legitimate tax planning could be pre-packaged.

Davis & Dann: fraudulent transactions

Davis & Dann Ltd v HMRC [2013] UKUT 0374 (TCC) concerned an appeal against the First-tier Tribunal’s (FTT) decision that HMRC was right to refuse to repay input VAT paid on purchases of consignments of razor blades, as the transaction was connected with fraudulent evasion of VAT.

Davis & Dann purchased the razor blades from Bristol Cash & Carry on the ‘grey market’ and sold them on to their customers. Subsequently, it was discovered that a distributor at the top of the transaction chain had acted fraudulently by not accounting for output VAT. No fraud was alleged against any other participant in this transaction.

The Upper Tribunal (UT) agreed with the FTT that the appropriate test was whether Davis & Dann should have known that the only reasonable explanation for this transaction was that it was connected to fraud; it is for HMRC to prove this. The FTT concluded that the various ‘warning signals’ in this particular transaction meant that this test was satisfied. The UT disagreed, commenting that, in their view, these ‘warning signals’ amounted to nothing more than ordinary business in the ‘grey market’. Even if there were elements of the transaction that may have led Davis & Dann to suspect the transaction was connected with fraud, this was insufficient. The UT noted that the burden on HMRC was high and it had failed to satisfy the relevant legal test.

Why it matters

This case illustrates that taxpayers are afforded a good level of protection from being penalised by HMRC for the fraudulent evasion of VAT by others. It is not enough for HMRC to merely prove the taxpayer should have suspected fraud from some of the circumstances of the transaction, or even that it should have known that it was more likely than not that the transaction was connected to fraud. This perhaps gives some reassurance to innocent taxpayers that are operating in markets that by their very nature are susceptible to fraud.

University of Huddersfield: abuse of law

In University of Huddersfield v HMRC [2013] UKFTT 429 (TC), the university had entered into a lease and leaseback arrangement with a discretionary trust effectively within its control (but not connected to it under the VAT legislation), in respect of a property which it wished to refurbish. Both parties opted to tax the property. The effect of these arrangements was that the university was able to recover all input VAT incurred in respect of the refurbishment works upfront, although, as a partially exempt trader, it would still suffer irrecoverable input VAT in respect of the ongoing rental payments. This gave the university a timing benefit, with the added possibility of obtaining an absolute tax benefit if the leases were collapsed. HMRC issued an assessment for the input VAT deducted, which the university appealed.

The FTT noted that the arrangements had, at the time of the assessment, only resulted in a deferral of VAT, rather than an absolute saving. As such, given that opting to tax was not, on the facts, contrary to the purpose of the VAT legislation at the time in question, the FTT held (following the CJEU in Weald Leasing, C-103/09) that the arrangements were not abusive. In this respect, the FTT did not consider that the fact that the supplies in question would have been exempt, had the university not entered into an option to tax, provided any justification for distinguishing the present case from that of Weald Leasing. Furthermore, the FTT held that the fact that the leases could be (and indeed in 2004 were) surrendered, allowing an absolute saving to be made, was irrelevant until the saving accrued. As it was normal to include a right to surrender in a lease, the inclusion of such a term in the arrangements did not make them abusive from the outset. However, HMRC had not made an assessment on those grounds and was now out of time to do so.

Why it matters

If upheld on appeal, this case supports the fact that Weald Leasing means that the Halifax principle only applies when a scheme results in an absolute saving of VAT, and not normally when it simply defers the VAT payment (for example by leasing, rather than buying, an asset). According to the FTT, for the Halifax doctrine to apply, there needs to be an absolute tax saving at the time of HMRC’s assessment and not just the possibility of one in the future.

Palatial Leisure: attribution of input VAT

In Palatial Leisure Ltd v HMRC [2013] UKFTT 396 (TC), HMRC had accepted, following the CJEU decision in Linneweber (C-453/02 and C-462/02), that Palatial’s supplies of gaming machines should have been treated as exempt for the period 1 October 2002 to 5 December 2005 (following which date the UK legislation was changed to cure the defect identified by Linneweber and ensure that supplies of gaming machines would be treated as taxable), but had required Palatial to make a corresponding adjustment to its input VAT claim for the same period. A dispute arose in respect of the period between 1 October 2002 and 31 March 2005, because HMRC contended that all the input VAT for this period should be attributed to exempt supplies (on the basis that Palatial’s gaming machine supplies in that period were properly exempt), whereas Palatial contended that such input VAT should be treated as ‘residual input tax’ on the basis that the machines, which had an average lifespan of seven years, were intended to be used for making both exempt supplies (before 6 December 2005) and taxable supplies (after 5 December 2005).

The FTT dismissed Palatial’s appeal, agreeing with HMRC that, for the purposes of attributing input VAT (under the VAT Regulations, SI 1995/2518, reg 101(2)), it is necessary to ascertain the use of goods at the time when the input VAT becomes chargeable.

Why it matters

The case is a reminder that, for the purposes of reg 101(2), there is no place for hindsight in ascertaining whether goods or services are used or to be used for making taxable supplies outside the longer period of adjustment (as specified in reg 107), except in the case of capital goods.

What to look out for

  • On 26 September, the CJEU judgments in the EU Commission’s infringement proceedings against various member states over the operation of the special scheme for tour operators (known as the tour operators’ margin scheme in the UK).
  • The Supreme Court will hear the taxpayer’s appeal in Secret Hotels2 on 29/30 January 2014 (on whether a supplier acted as principal or disclosed agent).