VAT and property update

This note brings together a number of recent developments in the area of VAT and property as well as noting the current status of issues that have yet to be finally resolved.

Input tax on the sale of a property as a going concern

Customs & Excise have issued their long awaited Business Brief setting out their reaction to the decision of the European Court of Justice in the Abbey National case. Customs' policy has been to treat the VAT on professional costs incurred in connection with the sale of an investment property as a going concern as non-attributable input tax. This has been on the basis that the sale of property as a going concern is neither a taxable nor an exempt supply. Accordingly, the non-attributable input tax is recoverable in accordance with the taxpayer's partial exemption method. Ordinarily, the taxpayer's partial exemption method will involve looking at the mix of taxable to exempt supplies of the taxpayer's business as a whole (or a significant part of it). This means that where a taxpayer that otherwise makes largely taxable supplies in its business as a whole, transfers an unelected investment property most of the VAT on professional costs associated with the sale will be recoverable.

Conversely, and this was the position that Abbey National was in, if the taxpayer has a poor recovery rate under its partial exemption method then even though the property being transferred is an elected property, only a small proportion of VAT on professional costs would be recoverable. In the Abbey National case, the taxpayer argued that because the underlying properties transferred were elected then the VAT on the professional costs associated with the sale should be recoverable. The taxpayer won with the ECJ holding that the VAT on professional costs incurred in relation to the sale could be attributed to the underlying taxable status of the property where the property transferred could be regarded as a clearly defined part of the taxpayer's business. The Business Brief issued by Customs & Excise is not very illuminating but in practice it seems that, usually, the taxpayer will be able to recover VAT on professional costs associated with the sale where the property sold is an elected property but will not be able to recover any VAT where it is not. There are two obvious areas of difficulty. First, in relation to portfolio sales where some of the properties are elected and some are not. Here it may be necessary for a taxpayer to obtain approval for an alternative partial exemption method where the taxpayer’s existing method would not ensure a fair and reasonable attribution of input tax. Second, some taxpayers may wish to make an election immediately before the sale with a view to obtaining full input tax recovery on sale costs. However, the permission of Customs & Excise to make an election may be required and taxpayers may find that permission will not be given where the reason for making an election is to secure input tax recovery on the sale costs.

Attribution of input tax to taxable and exempt supplies

It is understood that Customs & Excise have decided not to appeal further the Wiggett Construction case. This case concerned a developer that acquired land paying VAT on the price. The developer recovered the VAT on the basis that it intended to make zero-rated supplies of residential housing following the development of the land. Instead it entered into contracts with a housing association under which the developer sold the land to the housing association and as part of the agreed arrangements entered into a development agreement under which the developer supplied taxable supplies of construction services to the housing association. The land supply to the housing association took place as an exempt supply. Customs sought to claw back the VAT paid on the acquisition of the land by the developer on the grounds that it was properly attributable to the exempt land supply.

However, the taxpayer argued that the VAT should be regarded as attributable not only to the land supply but also the taxable supply of construction services to the housing association. It argued that the land supply and the supply of construction services should be regarded as a global arrangement. The taxpayer was successful in the VAT tribunal and the high court held that on the facts the VAT tribunal's decision was not a decision that was so unreasonable that the court was obliged to interfere with it. The decision is generally regarded as being unusual and it is understood that Customs & Excise will regard the case as being dependent very much on its own particular facts and will therefore not be making any policy changes in this area. Accordingly, taxpayers should continue to ensure that special care is taken to review the VAT position in development structures. It must be assumed that any VAT paid on the price of land acquired will be attributable to the sale on of that land.

Notification of the option to tax

It is understood that Customs & Excise have accepted the VAT tribunal's decision in the Chalegrove case which held that where a notification of an option to tax was sent by first class post, notification to Customs & Excise was made on the day that it was put into the post. Up until now, it has always been Customs & Excise policy that notification of the option to tax took place when Customs & Excise received it. The time at which Customs can be said to have been notified of the option to tax is of particular importance in the context of obtaining transfer of going concern treatment. In order to obtain TOGC relief, it is necessary to ensure that Customs & Excise are notified of the making of the option to tax no later than the date of completion. Even though Customs accept the Chalegrove decision, it will still be prudent to ensure that the option to tax is notified to Customs in good time where TOGC treatment is expected.

The option to tax and residential conversions/developments

Customs & Excise have announced a change of policy with effect from 1 August 2001 and which is made in the light of the VAT tribunal decision in SEH Holdings Limited. The VAT legislation operates to disapply a seller's option to tax where the land/building sold is to be used by the purchaser as a dwelling or where the purchaser converts or develops the building into dwellings for sale or rent. In the SEH Holdings case, the tribunal held that where A sells a building to B and B immediately sells to C, then the option to tax made by A will not be disapplied where C has the intention to use the building as a dwelling or convert/develop the building as a dwelling but B has no such intention. This is because C's intention is irrelevant to the supply made to B.

Whether A's option to tax is disapplied or not will be of considerable importance to the economics of the transaction. As Customs' policy in this area has not been clear, Customs will not insist that VAT must be charged on a sale to B in the circumstances where the sale takes place prior to 1 August 2001. From this date, VAT must be charged. Nevertheless, it must still be open to A to insist on the strict legal position so that VAT is chargeable immediately although A would need to ensure that he could pass this charge on to B under the terms of his contract.

More generally Customs & Excise have announced that they are reviewing this area, noting that there are particular difficulties in the context of auction sales where a seller may be unaware of the purchaser's intention prior to the day of the auction. Where a seller has set the price on the assumption that VAT will be paid by the purchaser but it transpires that the purchaser intends to use the building as a dwelling or otherwise convert it or develop it for such use this will have the effect of disapplying the seller's option to tax. This will result in irrecoverable input tax for the seller. Sellers need to be aware of this and consider carefully the provisions relating to VAT that they may need to include in contracts.

Input tax recovery prior to exercise of the option to tax

It is understood that the Court of Appeal will be hearing the appeal in the Royal & Sun Alliance case this month. This case concerns an insurance company that sub-let premises that became surplus to its own requirements. The insurance company paid VAT on rents to its landlord and opted to tax the rents payable under the sub-leases. Customs sought to deny the insurance company input tax recovery on the rents paid to its landlord during the period from the date on which the property became empty and the date on which it opted to tax the rents. The High Court held that the insurance company could recover the VAT for this period on the basis that the rents payable to the landlord were in reality a cost component of making the subsequent taxable supplies to the sub-lessees and was therefore properly attributable to the making of taxable supplies.

This case is of importance in establishing the extent to which VAT incurred prior to making the option to tax is recoverable where there have been no intervening exempt supplies eg where the property has been unoccupied.

Licence to occupy land?

The House of Lords have referred Sinclair Collis to the European Court of Justice. This case concerned a taxpayer that operated cigarette vending machines which were placed in pubs and similar establishments. Under the agreements between the taxpayer and publicans the taxpayer was entitled to operate the vending machines at the specified premises free of competition, in return for which the publicans would receive a share of the proceeds of sale. Both the High Court and the Court of Appeal had reached the conclusion that the publicans had made an exempt supply of a licence to occupy land. The majority of the House of Lords thought that the true nature of the supply was not a land supply but rather a facility to sell cigarettes from the vending machine (and therefore a standard rated supply). However, the House of Lords felt that the correct decision was to make a reference to the European Court of Justice. It is to be hoped that the European Court will give some clear guidance as to the parameters of the land exemption in this area.

Customs & Excise review of the option to tax

It is expected that Customs & Excise will complete their review of the operation of the option to tax and effect any policy changes by the end of this year. Two key areas under review are the definition of "building" for the purposes of the option to tax and the circumstances in which permission to opt to tax will be necessary.

It is expected that Customs will relax the strict statutory definition of building in certain areas. In particular, it is expected that where buildings are linked by a car park, public thoroughfare or because of statutory requirement (eg fire regulations) the link will be disregarded in determining whether two buildings are to be regarded as a single building for the purposes of VAT. The wide definition of building in the VAT legislation has given rise to difficulties in certain cases and these proposed changes should help in particular cases.

It is also expected that Customs will broaden the scope of the automatic permission to make the option to tax (as set out in Customs & Excise Notice 742) thereby reducing the number of circumstances in which it is necessary to obtain Customs'prior permission. The requirement to obtain prior permission can be problematic in circumstances where a transaction has a tight time deadline. Nevertheless, it is understood that Customs will retain the requirement for specific permission in specified cases.

Another likely change is the acceptance that an option to tax relates to both the building and the land upon which the building stands. Currently, Customs take the view that the option to tax relates to the building so that where the building is demolished, the option to tax evaporates. Some taxpayers have been caught out where they have failed to make a fresh option to tax on demolition of a building and redevelopment of the land. On the other hand, some taxpayers have used Customs'policy in order to remove the option to tax from specified land (by demolishing the building). There is likely to be transitional rules which will permit taxpayers who have opted to tax under the old policy regime to remain subject to the old rules.

For further information please contact Michael Boutell at [email protected] or on +44 (0)20 7367 2218 or Richard Croker at [email protected] or on +44 (0)20 7367 2149