Sale and leaseback transactions: when is a sale not a disposal?

United KingdomScotland

The VAT treatment of sale and leaseback transactions has been the subject of considerable uncertainty in recent years, culminating in defeat for HMRC in the Supreme Court in the case of Balhousie Holdings Ltd v HMRC. HMRC has now published its response which confirms that organisations in the care home, NHS or charities sectors which enter into sale and leaseback transactions similar to those conducted by Balhousie Care Ltd should not incur VAT self-supply charges. However, HMRC has reiterated its view that a sale and leaseback is two separate transactions, which suggests possible pergence from the recent European Court of Justice decision in the Belgian case of Mydibel SA and there remains a lack of clarity as to how it will treat sale and leaseback transactions in other circumstances.

The facts of the Balhousie case and its progress through the lower courts are explained in Jacob Gilkes’s article on the Supreme Court Blog here, see also the report on the Supreme Court judgments on that Blog here.

In brief, Balhousie Care Ltd (“Balhousie”) bought a care home and, instead of taking out a long term loan to finance the purchase, entered into a sale and leaseback arrangement under which Balhousie sold the property to a third party which immediately granted a 30 year leaseback to Balhousie. No VAT was payable on the sale of the care home to Balhousie as it benefited from zero rating due to the building being used for a “relevant residential purpose”. However, VAT legislation provided that the benefit of the zero rating would be clawed back if Balhousie disposed of its “entire interest” in the property within 10 years of the acquisition. HMRC maintained that Balhousie’s sale of the property was such a disposal despite the immediate leaseback and despite there being no break in Balhousie’s occupation and operation of the care home. The Upper Tier Tribunal and Scottish Court of Session agreed with HMRC that VAT legislation required each leg of the sale and leaseback to be treated separately and that Balhousie had to be treated as disposing of its entire interest in the property prior to the leaseback. However, the Supreme Court upheld Balhousie’s appeal and held that that there was no moment when Balhousie had disposed of its entire interest in the care home as the sale and leaseback were simultaneous and the purchaser bought subject to an obligation to grant the lease. Furthermore the term “entire interest” did not refer only to the property interest originally purchased by Balhousie but covered also the lease granted back to it.

Although the ECJ decision in Mydibel SA was published after HMRC won in the Court of Session and before the hearing in the Supreme Court, only one Supreme Court judge applied the ECJ’s rationale in finding for the taxpayer, the other four reaching their decision on the basis of interpretation of UK VAT legislation, holding that Balhousie had at all times held an interest in the property. The Mydibel case involved a sale and leaseback during the capital goods scheme adjustment period. The taxpayer had recovered input tax on the basis that it would use the property to make VATable supplies and the Belgian tax authorities argued that the VAT exempt sale of the land triggered a clawback of part of that input tax. The ECJ held that the sale and leaseback had to be treated as a single transaction for funding purposes which did not trigger a capital goods scheme input tax adjustment. (This seems to be a rare example of application of substance over form in VAT to benefit the taxpayer; it is predominantly used against taxpayers as part of the abuse of law doctrine). The Mydibel line of reasoning potentially has wider implications for sale and leaseback transactions generally than the Supreme Court’s interpretation of the meaning of the term “entire interest” for the purposes of a specific legislative provision, paragraph 36 (2) of Schedule 10 of the Value Added Tax Act 1994.

Revenue and Customs Brief 13 (2021) reiterates that HMRC views a sale and leaseback as two separate transactions but confirms that HMRC will not treat a person’s entire interest in a qualifying property as disposed of in sale and leaseback transactions provided that:

  • The lease is granted immediately so there is a “seamless transaction with no time lapse”
  • The lease must be for a term not less than the remainder of the 10 year period commencing on the original purchase.
  • The property must be continually used or operated for a qualifying purpose with no break in trade during the sale and leaseback.

However if these conditions are not met, HMRC state that a self-supply charge to VAT will apply.

This Brief is stated to be HMRC policy in relation to the self-supply charge relevant to Balhousie and is silent on HMRC’s policy towards sale and leaseback transactions in other contexts. While it would seem logical to assume that similar reasoning should apply, it is noteworthy that HMRC reiterates its view that a sale and leaseback is two separate transactions so it may not be safe to assume that it will necessarily follow the ECJ in Mydibel in treating sale and leaseback transactions undertaken for financing purposes as single transactions not involving a disposal of property. Taxpayers involved in such transactions may ultimately need to resort to the courts to seek to overturn adverse VAT assessments. For example, it is understood that in the recent unreported case of A Blue (UK) Ltd the FTT, relying on Mydibel, held that the sale of a head lease and immediate grant of a leaseback of part of the premises were “so inextricably linked” that they should be treated as a single transaction, the purchase by the buyer of the head leasehold interest in the part of the building not leased back.

SDLT

It is also worth considering whether these decisions will have an impact on how SDLT is applied on sale and leasebacks. For SDLT purposes a relieving provision exists meaning that the leaseback is not subject to SDLT where the appropriate conditions are fulfilled. However, the sale limb is still subject to SDLT on its market value under the SDLT exchange rules.

HMRC accept in their SDLT manual that market value does not include a VAT element; however, they are known to have taken the view in some sale and leaseback cases that the effect of the VAT barter rules is to impose a requirement to charge VAT on the sale, and that an SDLT charge on that VAT should follow. Advisers have questioned whether this analysis is the correct one in SDLT terms but HMRC seem to have taken the view that their hands are tied for SDLT purposes by the VAT analysis.

In the Balhousie decision, the Supreme Court considered the purpose of the VAT zero rating provisions, but did not find it necessary to consider the specifics of which supplies were made for VAT purposes. It was sufficient in their view that the ‘entire interest’ was not disposed of. The presence of the leaseback meant that the ‘seller’ retained sufficient interest despite the formal sale. This approach reflects that the economic value of the sale is affected by the presence of – or the obligation to grant – the leaseback. Given that this is the case, one might conclude that any VAT invoice issued in relation to the sale should reflect its encumbered value. This is an approach which would be entirely in line with the valuation of encumbered interests for SDLT purposes.

It follows that the problem of SDLT on the VAT invoice value should drop away if the VAT value of the sale is negligible. This point has been raised with HMRC and discussions are ongoing.