On 16 November 2012 HMRC published a Brief (Revenue & Customs Brief 30/12) setting out its response to the First-tier Tribunal (Tax) decision in Robinson Family Limited v HMRC. In short, HMRC has stated that it will not be appealing the decision and that it accepts that the grant of a lease over a let property is capable of being a transfer of a going concern (TOGC) provided that the lessor (seller) retains only a small reversionary interest such that the substance of the transferred asset is not altered.
A link to the HMRC Brief can be found here
Robinson Family Limited v HMRC
Due to restrictions on alienation in its head lease, Robinson Family Limited (RLF) effected a transfer of its letting business by means of the grant of a sublease. The sublease expired three days before the head lease, meaning that RLF retained a reversionary interest in the land. HMRC sought to impose VAT on the sale price, denying RLF TOGC treatment on the basis that the grant of the sublease amounted to the creation of a new asset rather than the transfer of an existing one, where the law, HMRC argued, required an existing asset to be transferred.
The First-tier Tribunal found against HMRC, holding that the transfer by RLF of its letting business amounted to a TOGC. Accordingly, VAT was not payable on the sale price. The basis for this decision was that the asset being transferred, namely the letting business, was in substance unchanged by the grant of the sublease; the legal nature of the assets constituting a business was subordinate to the analysis of the substance of that business. The letting business existed prior to the grant of the lease and continued to exist in substantially the same form after the lease was granted. The ability of the lessee to carry on the same business following the grant of the sublease effecting the transfer was unaffected by the means of transfer.
HMRC's response: Grant of a lease may be eligible for TOGC treatment
HMRC has stated that it will not appeal the First-tier Tribunal's decision. It accepts that the transfer of a letting business by means of the grant of a lease may amount to a TOGC; the fact that the lessor retains a small reversionary interest in the property transferred does not preclude the transaction from being a TOGC for VAT purposes, provided that the substance of the transaction is not altered.
However, HMRC has imposed a maximum size on the value of the reversionary interest that the lessor may retain before it will regard the substance of the transaction as altered: the value of the reversionary interest may not exceed 1% of the value of the value of the property immediately before the transfer (disregarding any mortgage or charge). To illustrate this, HMRC considers the transfer of a letting business by the grant of a 999 year lease out of a freehold. The freehold is valued at £1 million. The lessor is entitled to ground rent of £100 per year and this income stream, together with any other rights retained by the lessor, is valued at £2000. Since the value of the interest retained equates to only 0.2% of the value of the property immediately before the transaction, the substance of the transaction is not affected by the grant of the lease and so the transfer would not be precluded from being a TOGC.
HMRC response: A review of policy on whether a surrender of a lease is eligible for TOGC treatment
HMRC is also reviewing its policy on whether surrenders of interests in land can result in TOGCs but is yet to make a firm announcement on this front.
HMRC has promised further guidance regarding transfer by means of surrender. Given HMRC's analysis of transfer by means of grant, we can reasonably expect this area to open up too on the basis that the transferor does not retain any interest capable of altering the substance of the transaction.
The change of position on the VAT and TOGC treatment is material two respects:
For completed transactions of lease grants
In terms of the implications for completed transactions, whilst VAT may be refundable, it is likely that any lessee will have been able to recover the VAT incurred on the purchase of the business in the course of running the business. Lessees who have been unable to recover the VAT charged by lessors may find that the transfer was not eligible to be treated as a TOGC if they have not continued to operate the lessor's letting business.
Taxpayers that have paid irrecoverable VAT in these circumstances should consider their options and undertake a due diligence of the lease contract to ascertain what rights of recovery exist. Strict time limits operate so prompt action should be taken.
SDLT paid on the VAT inclusive consideration given for the lease grant is now likely to be treated as paid in error and again, prompt action to recover should be taken, where possible, these sums. In practical terms, this is likely to be the case for all grants of leases (where the other TOGC conditions are met) save those granted by partners to a partnership, which have slightly different rules based on market value.
For future grants of a lease
Looking forwards, it is now clear that transfers of letting businesses by means of the grant of a lease are capable of being regarded as TOGCs, provided, of course, that the other TOGC conditions are satisfied and that the value of any retained interests does not exceed one per cent of the value of the property immediately prior to the transaction in question.
Careful attention should be paid to the terms of the lease document to accurately reflect this change of HMRC position.
For future lease surrenders
Buyers contemplating future lease surrenders should carefully review the proposed terms and perhaps consider including wording allowing possible future treatment as a TOGC depending on the facts of the transactions. In practice, this is only likely to be of relevance where there is an existing property rental business which is being transferred through the surrender.