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Implications of sale and lease back

29th Jun 2016
VAT Consultant
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This is one of those very complex areas of VAT, which can appear to defy logic!

Legal Background: where a new Relevant Residential Purpose (RRP) or Relevant Charitable Purpose (RCP) building is constructed for, or sold to, an operator, subject to meeting certain conditions, the supply is zero rated. This of course represents a significant cost saving to, for example, a Nursing Home operator, who’s onward supplies are VAT exempt.

So far, so good.

However, there is a further rule which creates a self-supply in the event of a change of use of the building within ten years of purchase. The purchaser is deemed to have sold the building to himself at the standard rate. The value is tapered over the ten year period. It is also adjusted if the change of use applies to only part of the building. Even so, if the value of the self-supply exceeds £83,000, then there is an immediate obligation to register for VAT. (The company might, as in this case, already be registered for VAT.) Output tax is due at 20% of the value of the self-supply. And, in many cases, there is no input tax claim, as the onward supplies remain exempt.

A case in Scotland concerned a provider of nursing care, operating from 25 care homes. As part of a financial re-structuring, the company sold and leased back three of its properties. The day-to-day operation remained unchanged. However, HMRC ruled that the arrangement triggered the self-supply charge. The amount assessed was £825,000. It was commented on, in correspondence, that such a charge would be a ‘potentially business ending issue,’ given the existing financial difficulties the company was experiencing.

HMRC Guidance (VCONST21500) states, “if the entire interest held in a qualifying building is sold to another person, whether or not that person intends to use the building solely for a qualifying use, a change of use charge is due on the sale.” This follows the wording of Sch 10, para 36(2) which also refers to the disposed of a taxpayer’s entire interest in a property.

As you might expect, HMRC analysed the entire arrangement into a sale and a lease-back as separate and distinct transactions. It said that this is how VAT works, and that it was would breach the principle of neutrality to do otherwise.

In contrast the taxpayer argued that the two transactions were interdependent, so much so that they must be considered a single composite transaction. Since the building continued to be used as a care home, there was no change of use, therefore no self-supply can arise.

The tribunal held that the provisions of para 36(2) required a taxpayer to relinquish all and every interest in the relevant property and that this was not the case with a sale and lease back transaction.

The tribunal found assistance in the case of Sargaison v Roberts an input tax case from 1964. The relevant legislation read: “the whole of [the person’s] interest in the land in question … is transferred … to some other person” (Income Tax Act 1952, s314). Mr Justice Megarry commented on the “broader more popular language which invites a broader and less technical construction” and that the correct approach was to look at the substance of the transaction, rather than the machinery used to carry it through.

The tribunal stated that the sale and lease back transaction was a composite transaction forming a single commercial unity. It was an alternative to seeking bank lending, as a means of raising finance. Further, the lease company, Target Healthcare REIT Ltd at no time acquired the building free of the operator’s freehold interest. It did not become their property to dispose of as they chose.

Consequently, the Tribunal allowed the taxpayer’s appeal. Although the exact terminology is different, as the properties are located in Scotland, this looks like a significant case, which will benefit operators of RRP institutions, and also charities, which have benefitted from zero rating.

The decision is here:

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