The VAT rules providing that an option to tax (or VAT election) may be disapplied in certain circumstances have been around since 1997 but until recently there has been little case law providing guidance on how they should be interpreted. Two recent cases are considered below.
Background
The background to these two cases is that HMRC was concerned about exempt businesses, such as banks or insurers, setting up complicated arrangements involving connected companies being party to or granting long leases which were intended to defer blocked input tax (i.e. VAT that could not be recovered on building a new headquarters because the business is exempt). They were then either spreading/deferring the cost over the life of the long lease or seeking to sidestep the blocked input tax altogether.
Water Property Ltd v HMRC [2016] UKFTT 721 (TC)
The legislation is complex but in this recent tribunal decision the First Tier Tax Tribunal concluded that the UK legislation was to apply only where there was a tax avoidance purpose. More precisely, a contract providing for conversion of a former pub into a nursery (making exempt educational supplies) could not be aggregated with a contract for conversion of the remainder of the pub into residential units. So the rules could not apply even though, had a single contract covering both activities been entered into from the outset, they might. HMRC went against its own guidance and the tribunal commented: ‘We were surprised that this case came before the tribunal at all. The taxpayer had relied on the guidance issued by HMRC relating to phasing of developments [in paragraph 4.12 in VAT Notice 706/2…]. The booklet is issued to provide guidance to taxpayers. It is reasonable to expect taxpayers to reply upon it, otherwise what is the purpose of the guidance?’
PGPH Ltd v HMRC [2017] UKFTT 782
The case of PGPH turned on a point of construction in the legislation essentially whether the intention or expectation that the property might be used by a person or persons connected with him for exempt purposes (so triggering the disapplication of the option) was satisfied where a person unconnected with the taxpayer subsequently became connected with him. On the facts, the provision of finance to a person who became connected with the developer of the land subsequently triggered the rules.
What to watch out for
These rules are complex. Anyone incurring significant expenditure on acquiring, refurbishing or extending property can easily "trip over" this legislation even if the transaction in question is bona fide commercial e.g. Tenant Requested Modifications. Seeking advice in advance is crucial as the PGPH case illustrates. For taxpayers who have inadvertently breached the rules, the Water Property case may be a solution, although HMRC can be expected to appeal.