On appeal from: [2019] CSIH 7

The Supreme Court has unanimously allowed this appeal concerning zero-rated supplies under the Value Added Tax Act 1994 (“VATA“) and whether HMRC was entitled to claw back the benefit of the zero-rating from the Appellant, Balhousie Holdings Ltd.

The appeal arises from the acquisition of a care home in Scotland. On 7 March 2013, Balhousie Care Ltd (“BCL“), a company in the Appellant’s VAT group, acquired the Huntly Care Home in Scotland from the developer (the “Grant“). To finance the acquisition, BCL negotiated a sale and leaseback with Target Healthcare REIT Ltd (“Target“): it sold the care home to Target (the “Sale“) and Target leased the care home to BCL for 30 years (the “Lease“). The Sale agreement made clear that Target’s right to possession of the care home was subject to BCL’s rights under the Lease. BCL used the building as a care home at all material times.

The supply of land in the UK is generally exempt from VAT rather than zero-rated. This is not always helpful for the buyer as the seller cannot recover the VAT paid on its inputs so may charge the buyer a higher price. Therefore, the UK has designated certain supplies as zero-rated rather than exempt – the Principal VAT Directive (Council Directive 2006/112/EC) permits the UK to do this for clearly defined social reasons and for the benefit of the final consumer (here, the residential occupants of care homes). Schedule 8 of VATA sets out the various supplies which are zero-rated. Those relating to the construction of buildings (including care homes) are in Group 5 of Schedule 8. The relevant zero-rated supply in this case was the Grant by the developer to BCL as it was a first grant of a “major interest” (in Scotland, either the interest of the owner or the interest under a lease of not less than 20 years) in the care home (a building “intended for use solely for a relevant residential purpose“).

The issue is whether BCL, as the recipient of the zero-rated supply, then disposed of its “entire interest” in the care home by the Sale and Lease. If it did then, pursuant to paragraph 36(2) of Schedule 10 Part 2 of VATA, HMRC was entitled to impose a ‘self-supply charge’ on the Appellant, a mechanism which effectively clawed back the benefit of the zero-rating. The Inner House of the Court of Session decided that BCL did dispose of its entire interest as the Sale disposed of exactly the interest which BCL acquired by the zero-rated Grant, regardless of the Lease which BCL received. The two transactions had to be considered separately from each other, even though (as the First-tier Tribunal had found) they were simultaneous.

The Supreme Court unanimously allowed the appeal and found that BCL did not dispose of its entire interest in the care home. Therefore, HMRC was wrong to claw back the benefit of the zero-rating. Lord Briggs gave the main judgment, with which Lord Hodge, Lord Sales and Lord Carloway agree. Lady Arden gave a concurring judgment.

The Court reasoned that paragraph 36(2)’s purpose is to encourage the recipient of the zero-rated supply to maintain some level of economic interest in the premises and therefore commit to the project of creating and operating the building for the specified socially desirable residential or charitable use for ten years after its completion.

Construing paragraph 36(2) with this purpose in mind, first “entire” means exactly what it says – that the recipient of the zero-rated supply no longer has any interest in the premises. Second, paragraph 36(2) is concerned with the existence of a state of affairs: did a time come when BCL no longer had any interest in the care home? Paragraph 36(2) is not concerned with whether this state of affairs arises from a single transaction or from a series of transactions. For this reason, the Inner House was wrong to focus on whether the Sale and Lease could be treated as a single transaction and the case law from the European Court of Justice (ECJ) on whether multiple transactions need to be viewed separately or together for VAT purposes is irrelevant. After all, the recipient of the zero-rated supply does not need to dispose of its entire interest by a taxable supply – it could dispose of it by gift. On the facts as found by the First-tier Tribunal, there was no moment when BCL had disposed of its entire interest in the care home. This is because the Sale and Lease were simultaneous so BCL either had an ownership interest or a leasehold interest at all relevant times.

Further, HMRC was wrong to treat the “interest” as the specific interest that BCL acquired by the Grant (ownership), such that disposing of the ownership interest, no matter what happened at the same time, meant triggering the self-supply charge. This is clear from paragraphs 35(2) and 37. Otherwise, paragraph 36(2) would have surprising consequences (for example, if the recipient of a zero-rated first grant of a lease later acquired full ownership and then disposed of only a lease) or would fail to work (for example, if instead of a zero-rated first grant, the zero-rated supply is of specified construction services or building materials).

For judgment, please see: Judgment

For non-PDF version of the judgment, please see: BAILII

For press summary, please see: Press summary

Watch hearing
26 Jan 2021 Morning session Afternoon session
27 Jan 2021 Morning session