In University of Huddersfield Higher Education Corporation v HMRC7, the Court of Appeal has dismissed the taxpayer’s appeal against the UT’s decision that a lease and leaseback scheme offended the Halifax abuse of rights principle. Accordingly, the transaction had to be re- characterised for VAT purposes so that the taxpayer’s input tax on construction services was recoverable in accordance with its partial exemption method (and not fully recoverable as attributable to taxable supplies made under the lease).
In 1996, the taxpayer entered into a lease and leaseback arrangement with the trustees of a discretionary trust for a site known as “East Mill”. The taxpayer elected to waive the VAT exemption over East Mill with the effect that the rent payable under the lease to the trustees was subject to VAT at the standard rate. The trustees also elected to waive the VAT exemption over East Mill so that VAT at the standard rate was chargeable on the rent payable under the leaseback to the taxpayer. The lease and leaseback contained a break clause that allowed the tenant to terminate the lease before the expiry of the term.
The taxpayer redeveloped East Mill and sought to reclaim the input VAT incurred on the redevelopment costs on the basis that the input VAT was attributable to the taxpayer’s taxable supplies of East Mill.
On 26 January 2000, HMRC issued an assessment denying the recovery of input VAT. The taxpayer appealed. On 16 October 2002, the FTT referred the case to the ECJ and made the following findings of fact:
- the lease and leaseback were genuine transactions resulting in genuine supplies
- the sole reason for using the trust, and the sole purpose of the lease to the trustees, was that of facilitating VAT planning
- the transactions into which the taxpayer entered provided for VAT deferral with an absolute VAT saving if the break was exercised and it was the taxpayer’s intention to exercise a break or surrender the lease before the expiry of the term
- the transactions were entered into with the sole intention of obtaining a fiscal advantage and it was the subjective intention of the taxpayer and the trust to achieve that fiscal advantage.
On 18 August 2004, the leases were surrendered.
The ECJ said that the lease and leaseback were supplies of goods and services, and constituted an economic activity. However, the ECJ did not comment on whether the transactions amounted to an abuse of rights. Instead, it stated that a deduction for input VAT arising as a result of transactions that constitute an abusive practice should be denied. The case was referred back to the FTT for a decision on whether there was an abuse of rights.
The FTT found in favour of the taxpayer. HMRC appealed that decision to the UT who found in favour of HMRC. The taxpayer appealed to the Court of Appeal.
Court of Appeal judgment
In the view of the UT, the essential aim of the transactions was, undoubtedly, the obtaining of a tax advantage. The taxpayer had, as a result of the transactions taken as a whole, treated the input tax on the building works as being linked to the taxable supply of the lease, rather than to its general (mainly exempt) supplies and therefore recovered 100%, rather than only a small proportion of it. This constituted a tax advantage. Given that the ECJ in Halifax had stated that, to permit a taxable person that made only exempt supplies to recover all of its input tax would be contrary to the principle of fiscal neutrality, the tax advantage obtained by the taxpayer was contrary to the purposes of the Sixth Directive and the national implementing legislation.
The Court of Appeal distinguished HMRC v Weald Leasing Ltd8, which concerned the deferral of irrecoverable VAT over the term of a lease from the instant case, where the scheme could be collapsed in order to obtain an absolute saving. The FTT had found that this was the taxpayer’s intention from the outset. In the view of the Court, in considering whether the first limb of the Halifax principle (that the transactions resulting in the tax advantage were contrary to VAT law) was satisfied, the UT had been correct to focus on the object, purpose and effect of interposing the trust and granting the lease and leaseback, which had no commercial effect other than to secure a tax advantage.
In re-characterising the transactions, the Court said that its task was to disregard the abusive (artificial) elements of the scheme (in this case, the trust and lease and leaseback) and not, as the taxpayer had argued, to substitute it for an alternative scheme that the taxpayer could have implemented (a similar lease arrangement but at arm’s length).
Given the FTT’s finding of fact that there was an intention from the start to collapse the leases (and obtain an absolute VAT saving), and the UT distinguishing Weald Leasing, the Court of Appeal’s judgment is not surprising.
Leasing is not in itself abusive. Partially exempt taxpayers may choose to spread irrecoverable VAT over the lease period, but a lease designed to achieve an absolute VAT saving will be open to challenge by HMRC.
A copy of the Court of Appeal’s judgment is available to view here.