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In this post, Jacob Gilkes, a member of the tax team at CMS, previews the decision awaited from the UK Supreme Court in the matter of Balhousie Holdings Limited v The Commissioners for Her Majesty’s Revenue & Customs, which concerns whether a sale and leaseback transaction should be regarded for VAT purposes as a disposal by the seller of its “entire interest” in the building. 

On 26 and 27 January 2021, the UK Supreme Court heard the appeal in the matter of Balhousie Holdings Limited v The Commissioners for Her Majesty’s Revenue & Customs. The appeal concerns whether, in the context of the VAT self-supply charge which can arise on the disposal of a building which has been subject to a zero-rated acquisition, a sale and leaseback of the property involves a disposal of the “entire interest” in the building.

Background

Balhousie Care Limited (“Balhousie Care”) acquired a care home in Huntly, Aberdeenshire from a related company which had constructed the care home. The sale of the care home to Balhousie Care was zero-rated for VAT purposes. In order to finance the acquisition, Balhousie Care entered into a sale and leaseback agreement with an unconnected third party which subsequently acquired Balhousie Care’s interest in the property and immediately granted a 30 year lease back to Balhousie Care. Following the transaction, HMRC determined that the taxpayer, as representative member of the VAT group of which Balhousie Care was a member, was liable for a VAT self-supply charge as a result of the disposal of the care home by Balhousie Care.

The provisions in relation to the self-supply charge are set out in the Value Added Tax Act 1994, Sch 10, paras 35-37. Where a taxpayer has received a zero-rated supply of a building intended for use for “relevant residential purposes” and, within 10 years of that zero-rated supply, either disposes of its “entire interest” in the building or ceases to use the building for a “relevant residential purpose”, a self-supply charge arises. HMRC determined that, although the sale of the property by Balhousie Care was immediately followed by the grant of the lease back to Balhousie Care, the sale nevertheless constituted the disposal of Balhousie Care’s “entire interest” in the building.

First-tier Tribunal

The taxpayer appealed to the First-tier Tribunal which allowed the appeal. The court explained that the reference to a disposal of the “entire interest” in the building required a taxpayer to relinquish all and every interest in the relevant building. The court acknowledged that, in relation to direct taxes, the case law indicated that the correct approach was to look at the overall outcome of a composite transaction, and the courts had concluded that a sale and leaseback transaction should not be regarded as an absolute disposal by a taxpayer, notwithstanding that, from a strict property law perspective, there would be a moment immediately after the sale and immediately before the leaseback when the taxpayer had no interest in the property. Applying these principles, the court concluded that the sale and the leaseback should be regarded as a composite transaction which merely resulted in a change in the legal form of Balhousie Care’s interest in the building, such that Balhousie Care had not disposed of its “entire interest”.

Upper Tribunal

HMRC appealed to the Upper Tribunal which allowed HMRC’s appeal. The court explained that the First-tier Tribunal should not have applied the same principles as used in relation to direct taxes, and had therefore erred by looking at the overall effect of the sale and leaseback. The court concluded that for VAT purposes the separate elements of a composite transaction should be looked at individually rather than as a single transaction. The court held that Balhousie Care had disposed of its “entire interest” in the building as it had disposed of all the rights which it had acquired in the original zero-rated acquisition of the care home. The taxpayer argued that Balhousie Care retained part of its original interest as it continued to enjoy a right of occupation following the leaseback. The court dismissed this argument on the basis that the right of occupation following the grant of the lease was a different right as it arose from the lease rather than from the original zero-rated acquisition.

Court of Session

The taxpayer appealed to the Court of Session which dismissed the appeal. The taxpayer’s main argument was that the court should use a similar interpretation to direct taxes and so use a substance over form approach, taking into account Balhousie Care’s underlying purpose or intention. The court identified four key principles of VAT, in particular that it was transactional in nature and that an objective approach should be followed in analysing transactions, and concluded that the taxpayer’s suggested approach was fundamentally inconsistent with these basic principles on which VAT was based. Applying these VAT principles the court, without referring back to the Upper Tribunal’s decision, reached the same conclusion as the Upper Tribunal that a sale and leaseback should be regarded for VAT purposes as two distinct transactions, a sale followed by the leaseback. The court concluded that the sale of the property therefore resulted in Balhousie Care divesting itself of its “entire interest” in the building such that a self-supply charge arose.

The court also rejected the taxpayer’s argument that treating the sale and leaseback as a single transaction would be consistent with the purposes of the relevant statutory provisions. The court concluded that the statutory provisions explicitly dealt with both a change of use and a disposal, and so the fact that a sale and leaseback may not result in a change of use does not necessarily make it consistent with the legislation. The court was able to identify situations where a sale and leaseback could ultimately give rise to an outcome which was contrary to the purposes of the legislation.

Comment

Shortly after the Court of Session’s decision, the CJEU issued its decision in Mydibel SA [2019] EUECJ C-201/18 which casts doubt on the Court of Session’s conclusion. Mydibel SA concerned the application of the VAT capital goods scheme, rather than the application of the self-supply charge. However the court indicated, without setting out a detailed analysis of the principles of VAT law, that it would expect the national court (in this case in Belgium) to regard a sale and leaseback transaction entered into for financing purposes as a single transaction for the purposes of the capital goods scheme. It will be interesting to see whether the Supreme Court follows the CJEU’s approach in the context of the self-supply charge.