THOROGOOD PROFESSIONAL INSIGHTS
A SPECIALLY COMMISSIONED REPORT
VAT LIABILITY AND THE IMPLICATIONS OF COMMERCIAL PROPERTY TRANSACTIONS
Tim Buss
AITT
THOROGOOD PROFESSIONAL INSIGHTS
A SPECIALLY COMMISSIONED REPORT
VAT LIABILITY AND THE IMPLICATIONS OF COMMERCIAL PROPERTY TRANSACTIONS Tim Buss
AITT
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DEDICATION
To my family and in memory of Peter, my dad and Joan, my mother in law.
The author Tim Buss is a VAT director in the Guildford office of accountants and business advisors PKF and specialises in VAT and property issues. However, he advises clients on all aspects of VAT. Tim has represented clients at VAT tribunals including SEH Holdings referred to in this book. Prior to joining PKF in 1989, Tim spent 16 years in H.M. Customs & Excise (Customs) as a VAT inspector and later as a classroom trainer of new entrants. His departure from Customs coincided with the introduction of VAT on new commercial buildings. Tim is an associate and council member of the Institute of Indirect Taxation and in 2002 was appointed the Institute’s Director of Education. This entails responsibility for the Institute’s examinations. Tim regularly writes on a range of VAT issues. He lectures and presents workshops for a number of organizations including the Association of Accounting Technicians, Institute of International Accountants and IBC Global Conferences.
THOROGOOD PROFESSIONAL INSIGHTS
Contents
INTRODUCTION VAT and property – a marriage made in Europe .....................................1
1
VAT GENERAL PRINCIPLES
3
The VAT regime ...........................................................................................4 VAT legislation .............................................................................................4 Registration ..................................................................................................5 Rates of VAT .................................................................................................5 Scope of VAT ................................................................................................5 Output tax .....................................................................................................7 Input tax ........................................................................................................7 Time of supply ..............................................................................................8
2
VAT LIABILITY OF COMMERCIAL PROPERTY TRANSACTIONS
9
UK legislation .............................................................................................10 European legislation..................................................................................10 Exceptions from exemption in the UK ....................................................12 Freehold sales of commercial buildings or civil engineering works.....13 Definition of an RCP building...................................................................13 Gaming and fishing rights ........................................................................14 Hotel accommodation ...............................................................................14 Holiday accommodation ...........................................................................15 Caravan and tent pitches or camping facilities ......................................16 Parking facilities.........................................................................................16 Sports facilities...........................................................................................18
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CONTENTS
3
LAND AND LICENCE TO OCCUPY LAND
19
Definition of land .......................................................................................20 Buildings .....................................................................................................20 Scope of the exemption for land and buildings .....................................21 Immovable property ..................................................................................21 Licences to occupy.....................................................................................22 Licence to use facilities..............................................................................23 Customs’ examples ....................................................................................24
4
OPTION TO VAT
26
Introduction................................................................................................27 Why opt? ....................................................................................................27 Commercial considerations......................................................................27 Interaction with stamp duty land tax ......................................................28 Option ineffective.......................................................................................28 Scope of an option to tax ..........................................................................29 Who can opt? .............................................................................................30 How is the option exercised? ...................................................................32 Option to tax – national unit .....................................................................33 Problems with notifications/acknowledgements ...................................34 Adding VAT to rents..................................................................................34 Informing tenants ......................................................................................35 Subsequent works .....................................................................................35 Is an option valid?......................................................................................36 Permission to opt regime..........................................................................37 Revocation of an option ............................................................................41
5
VAT ON TRANSACTIONS RELATING TO LEASES
42
Introduction................................................................................................43 Lease surrenders........................................................................................43 Variation of the terms of a lease...............................................................44 Reverse premiums .....................................................................................44
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CONTENTS
Assignment of a lease................................................................................45 Dilapidation payments ..............................................................................46 Rent free periods .......................................................................................46
6
CALCULATING RECOVERABLE VAT IN THE PROPERTY SECTOR
47
Introduction................................................................................................48 Partial exemption .......................................................................................48 Standard partial exemption method .......................................................49 Annual adjustment ....................................................................................49 Special methods .........................................................................................50 Partial exemption de minimis limits ........................................................51 VAT recovery – change of use ..................................................................51 Abortive and speculative developments .................................................52 Recovery of VAT prior to an option to tax..............................................52
7
CAPITAL GOODS SCHEME
54
Why have a Capital Goods Scheme? ......................................................55 Application of the scheme ........................................................................55 Additions to the scheme ...........................................................................56 Definition of a capital item........................................................................56 Where CGS does not apply ......................................................................57 Initial VAT recovery ...................................................................................57 Value ...........................................................................................................58 Intervals ......................................................................................................59 Example ......................................................................................................60 CGS effect on other disposals ..................................................................61 Record keeping ..........................................................................................62
8
TRANSFERS OF GOING CONCERNS
64
Introduction................................................................................................65 The UK legislation .....................................................................................65 Consequences of TOGC treatment ..........................................................66
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CONTENTS
Seeking Customs confirmation ................................................................67 European dimension ................................................................................68 Interaction between the TOGC and property rules ...............................69 Relevant date ..............................................................................................70 Customs’ views .........................................................................................71 TOGC benefits............................................................................................71 A capital goods scheme issue...................................................................72 Recovery of VAT on costs of TOGC transactions ..................................72
9
VAT AVOIDANCE
73
Introduction................................................................................................74 Option for VAT planning ..........................................................................74 Customs efforts to combat avoidance .....................................................75 Anti-avoidance legislation ........................................................................75 Disclosure rules..........................................................................................78
10
CONVERSIONS TO DWELLINGS AND RRP BUILDINGS
79
Introduction................................................................................................80 Examples of conversion from non-residential .......................................80 Disapplication of the option to tax...........................................................81 Relevant residential purpose ....................................................................82
11
OPTION TO TAX – PAST, PRESENT AND FUTURE
84
Introduction................................................................................................85 The past.......................................................................................................85 The present .................................................................................................87 The future ...................................................................................................87
APPENDIX
90
Ten tips and ten traps ................................................................................91
THOROGOOD PROFESSIONAL INSIGHTS
Introduction
VAT and property – a marriage made in Europe Most people can remember where they were when news broke of a worldshattering event, e.g. the assassination of President Kennedy or the death of Princess Diana. As testament to a ‘sad life’ as a VAT consultant, I can remember precisely where I was on 21 June 1988 (in my car and on my way to address a meeting of the West Wycombe Women’s Institute) when the European Court of Justice (ECJ) released its judgement against the UK’s zero rated treatment of commercial property transactions. The judgement of the ECJ heralded the most significant changes in the history of VAT in the UK. The necessary legislative amendments came into effect on 1 April 1989. The main areas of change were as follows: •
Zero-rating for new construction was restricted to dwellings and buildings for a relevant residential purpose (RRP) or a relevant charitable purpose (RCP).
•
Zero-rating for approved alterations to listed buildings was similarly restricted to dwellings, RRP and RCP buildings, and churches.
•
Zero-rating for the grant of a major interest, i.e. freehold sale or grant of a lease for a term of over 21 years was also confined to dwellings, RRP and RCP buildings.
Freehold sales of new commercial buildings and of new civil engineering works became standard rated. The option to tax was introduced; however, the option to tax rules did not come into effect until a few months later on 1 August 1989. Significantly there were no anti-avoidance regulations introduced in connection with the option to tax facility. This report is written at a time of uncertainty in the VAT and property world. At the time of writing important decisions of the ECJ are awaited, particularly the Halifax case (see Chapter 9). This report deals with the complexities of UK and EU legislation, and provides an overview of the implications of commercial property transactions. Residential property transactions are not within the
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INTRODUCTION
scope of the report with the exception of conversions to residential from nonresidential property. The VAT rules, procedure and interpretation of the legislation are constantly changing. Every property transaction should be considered on its merits. This report is not a substitute for professional advice. Tim Buss PKF
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Chapter 1 VAT general principles The VAT regime .....................................................................................4 VAT legislation .......................................................................................4 Registration ............................................................................................5 Rates of VAT ...........................................................................................5 Scope of VAT ..........................................................................................5 Output tax...............................................................................................7 Input tax..................................................................................................7 Time of supply ........................................................................................8
Chapter 1 VAT general principles In order to appreciate the VAT implications of property transactions it is necessary to be aware of certain basic principles of the tax.
The VAT regime VAT was introduced into the UK on 1 April 1973 as a condition of the UK joining the European Single Market. VAT is an indirect tax, under the care and management of H.M. Customs & Excise (Customs). VAT is a multi-staged tax which is imposed at each stage of a chain of supplies of goods or services.
VAT legislation The UK law is contained in the VAT Act 1994 which is supported by numerous statutory instruments. Customs publish public notices and certain parts of the notices (always highlighted) have the force of law. Where a section does not have the force of law, the notice represents Customs’ interpretation and opinion of particular VAT issues. Notwithstanding the terms of the UK legislation the UK Government is obliged to implement the provisions contained in EU Directives. The principal directive is the Sixth Directive. If the UK has not implemented EU provisions a UK taxpayer, but not Customs, can rely on the European directive where this would be to his or her benefit. In effect EU law overrides domestic law. An example is the proceedings taken against the UK in 1988. The ECJ ruled that the UK had not upheld the provisions of the Sixth Directive by allowing zero rating of commercial buildings (and water, news services, fuel and power). Where a question of European law is raised in the UK Courts or tribunals the matter can be referred to the ECJ for a preliminary ruling on the interpretation of the European law involved.
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1 VAT G E N E R A L P R I N C I P L E S
Judgements of the ECJ must be followed in the UK even where the cases concerned are those of another member state.
Registration The UK has adopted a registration threshold which is currently £60,000 with effect from 1 April 2005. The threshold is by far the highest in any of the member states of the European Union. Businesses whose turnover does not reach the registration threshold are not required to register for VAT, but can register voluntarily. Once registered, a business has to charge VAT (where applicable) on income and subject to certain rules can recover VAT on related costs and expenses.
Group registration Subject to certain conditions in respect of control, two or more companies established in the UK can, if they wish, register for VAT as a single entity. The principal advantage of choosing to group register is that most supplies between VAT group members are ‘disregarded’ for VAT purposes. Group registration means that only one VAT return is submitted for the group.
Rates of VAT The rate of VAT is currently 17.5%. There is a reduced or lower rate of 5% and a zero rate (nil %) which applies to certain goods and services. The zero rated goods and services concerned are listed in the VAT Act 1994, Schedule 8, and those at the lower rate are specified in VAT Act 1994, Sch 7A. In addition, other supplies are exempt from VAT (VAT Act 1994, Schedule 9) and others are outside the scope of UK VAT.
Scope of VAT In order to fall within the scope of UK VAT a supply has to meet the following conditions: •
it is a supply of goods or services;
•
it takes place in the UK;
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1 VAT G E N E R A L P R I N C I P L E S
•
it is made by a taxable person; and
•
it is made in the course or furtherance of any business carried on by a taxable person.
A transaction which does not meet the conditions is outside the scope of VAT.
Supply In broad terms a supply of goods occurs when the ownership of the goods is transferred. The freehold sale of a property is therefore a supply of goods. A supply of services is anything which is not a supply of goods but is done for a consideration. The letting of property is a supply of services. A free supply of services is outside the scope of VAT, generally referred to as non-business.
Place of supply There are complex rules for determining where a supply takes place. As far as property is concerned the place of supply is the UK if the property is located in the UK. The UK includes England, Scotland, Northern Ireland, Wales and the territorial waters of the UK. The Isle of Man, whilst not strictly part of the UK, is treated as though it is part of the UK for VAT purposes. This treatment does not extend to the Channel Islands.
Taxable person A taxable person is defined in UK law as anyone who is or is required to be registered for VAT. However, the definition in the Sixth Directive is far broader. Article 4 paragraph 1 states: ‘“Taxable person” shall mean any person who independently carries out in any place any economic activity specified in paragraph 2, whatever the purpose or results of that activity.’. The economic activities specified in paragraph 2 of Article 4 crucially for the purposes of this report include: ‘The exploitation of tangible or intangible property for the purpose of obtaining income there from on a continuing basis shall also be considered an economic activity.’
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1 VAT G E N E R A L P R I N C I P L E S
Business The definition of business in UK law is in the VAT Act 1994, Section 94. This states that business includes ‘any trade, profession or vocation’. However, the term ‘business’ is far wider and covers activities not normally treated as a business under direct tax law, e.g. the letting of property.
Output tax The tax charged on supplies is known as output tax. Output tax is calculated at either 17.5% or 5% (as appropriate) of the value of the supply. The value on which VAT is chargeable on a supply is determined in accordance with rules in the VAT Act 1994, Section 19: ‘If the supply is for a consideration in money its value shall be taken to be such amount as, with the VAT chargeable, is equal to the consideration.’ The effect of this is where the consideration does not specify VAT; the consideration shall be taken to be VAT inclusive.
Input tax Input tax is defined in the VAT Act 1994, S24 (1), as the tax on goods or services supplied to a person, tax on the acquisition of goods from a member state (and the tax payable on importation) being, in each case, goods or services used, or to be used, by a person for the purpose of any business carried on, or to be carried on, by the person concerned. A business can recover VAT on costs relating to taxable transactions (at the standard rate, lower rate and zero rates). A claim for input tax must be supported by a tax invoice unless Customs agree or direct otherwise. It is critical to land and property transactions to remember that VAT cannot be recovered on costs relating directly or indirectly to exempt supplies. Where a business makes both taxable and exempt supplies, there are particular rules known as partial exemption rules (see Chapter 7) which may restrict the amount of VAT that a business can reclaim.
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1 VAT G E N E R A L P R I N C I P L E S
Time of supply VAT becomes chargeable at a specific time (known as the tax point). VAT must be accounted for by reference to the VAT return period in which the tax point occurs (unless the business is operating a special cash accounting scheme). The rules for determining the tax point differ depending on whether the supply is a supply of goods or a supply of services. The tax point rules with an emphasis to property transactions are described below.
Goods Where the supply is of goods the tax point is the date the goods are removed. For property transactions the tax point is the date the property is made available to the purchaser, normally the completion date. However, this tax point known as the basic tax point is overridden by what are termed actual tax points. Actual tax points are payments received (i.e. deposits) or invoices issued in advance of the basic tax point, or the date of invoice provided the invoice is issued within fourteen days of the basic tax point. The facility exists to agree with Customs an extension of the fourteen day period, e.g. if the business concerned normally issues invoices monthly.
Services The basic tax point for a supply of services is when the services are performed. Customs generally interpret this as meaning the date on which all the work, except invoicing, is completed. The basic tax point is overridden by actual tax points as described in the previous paragraph.
Continuous supplies of services There are special tax point rules for what are termed continuous supplies of services. The rules are necessary because for continuous supplies there is no performance tax point as the services are never completed. The leasing and letting of property falls within the continuous supply rules. For leasing and letting the tax point is the earlier of date of issue of tax invoice or receipt of payment.
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Chapter 2 VAT Liability of commercial property transactions UK legislation .......................................................................................10 European legislation............................................................................10 Exceptions from exemption in the UK ..............................................12 Freehold sales of commercial buildings or civil engineering works..................................................................13 Definition of an RCP building ............................................................13 Gaming and fishing rights..................................................................14 Hotel accommodation .........................................................................14 Holiday accommodation .....................................................................15 Caravan and tent pitches or camping facilities................................16 Parking facilities...................................................................................16 Sports facilities.....................................................................................18
Chapter 2 VAT Liability of commercial property transactions
UK legislation The VAT legislation (VAT Act 1994, Sch 9, Group 1) exempts: ‘The grant of any interest in or right over land or of any licence to occupy the land, or, in relation to land in Scotland, any personal right to call for or be granted any such interest or right.’ Note (1) to Group 9 states that ‘Grant includes an assignment or surrender and the supply made by the person to whom an interest is surrendered when there is a reverse surrender’. Note (1A) defines a reverse surrender as ‘one in which the person to whom the interest is surrendered is paid by the person by whom the interest is being surrendered to accept the surrender’. The inclusion of reverse surrenders (a term which appears to have been invented by Customs) within the exemption may be incorrect under European law (see chapter 5).
European legislation The UK legislation expresses the exemption by employing English land law terminology. It is interesting that the over-riding law on VAT, the EC Council Sixth Directive, expresses the exemption rather differently. Grant of an interest and licence to occupy is not mentioned. Instead there are three distinct categories of exemption: •
the leasing or letting of immovable property;
•
the supply of buildings; and
•
the supply of land.
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2 VAT L I A B I L I T Y O F C O M M E R C I A L P R O P E R T Y T R A N S A C T I O N S
Leasing and letting Article 13B(b) of the Sixth Directive exempts the ‘leasing or letting of immovable property’. There are specific exclusions which broadly the UK has followed (see below). Article 13B (b) excludes the following from the exemption: •
The provisions of accommodation, as defined in laws of the member states, in the hotel sector or in sectors with a similar function, including the provision of accommodation in holiday camps or on sites developed for use as camping sites;
•
The letting of premises and sites for parking vehicles;
•
Lettings of permanently installed equipment and machinery;
•
Hire of safes.
The Article allows member states to apply further exclusions from the scope of the exemption. The UK has followed the exclusions referred to above with the exception of hire of safes. There is no specific exclusion in UK legislation for the hire of safes. The UK’s position is that specific exclusion is unnecessary as exemption does not apply to articles not fixed to the land.
Supply of buildings Article 13B (g) exempts ‘the supply of buildings and parts thereof and land on which they stand’. The supply before occupation of buildings or parts of buildings and the land on which they stand is specifically excluded from the exemption. This exclusion therefore provides that the supply of new commercial buildings is liable to VAT.
Land Land is subject to a separate exemption under Article 13B (h) which exempts the supply of land which has not been built on other than ‘building land’. However, Article 28 of the Sixth Directive allows member states to retain exemption for building land, and most member states including the UK have done so.
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2 VAT L I A B I L I T Y O F C O M M E R C I A L P R O P E R T Y T R A N S A C T I O N S
Building land The UK rule on the VAT liability of building land was challenged in the case of Norbury Developments Limited v C & E Commissioners, CJEC (1999) STC511 (TBC21.307). The VAT tribunal held that the sale of building land is taxable rather than exempt, unless the exemption was authorised by Article 28(3) (b) of the Sixth Directive. The VAT tribunal referred the case to the ECJ which held that the UK was entitled to exempt the supply under Article 28(3) (b). The exemption for building land is however transitional and at some stage the UK will have to tax sales of building land. The obvious question will then be how to define building land.
Exceptions from exemption in the UK The specific exceptions to the exemption in the UK are contained in the VAT Act 1994, Sch 9, Group 1, Item 1. In broad terms the exceptions, which are liable to VAT, are as follows: •
Freehold sales of new or uncompleted commercial buildings or civil engineering works. New is defined as completed within the three years before the grant concerned.
•
Rights to take game or fish.
•
The provision in a hotel, inn, boarding house or similar establishment of sleeping accommodation.
•
The grant of interest in, right over or license to occupy holiday accommodation.
•
The provision of seasonal pitches for caravans and the grant of facilities at caravan parks.
•
The provision of pitches for tents or of camping facilities.
•
The grant of facilities for parking a vehicle.
•
The grant of any right to fell and remove standing timber.
•
The grant of facilities for housing or storage of an aircraft or for mooring, or for storage of any ship, boat or vessel.
•
Sports facilities.
•
Viewing accommodation at sports grounds, theatres etc.
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•
The grant of any right including an equitable right, a right under an option or right of pre-emption or in relation to Scotland, a personal right, to acquire an interest in land which would be taxable under one of the exceptions described above.
The more common exceptions are considered in detail.
Freehold sales of commercial buildings or civil engineering works The freehold sale of new or uncompleted buildings or civil engineering works is subject to VAT at the standard rate, currently 17.5%. The standard rate is applied to every, ie not just the first, sale of the freehold of a new or uncompleted building until three years after the earlier of the certificate of practical completion or first full occupation. In the case of a civil engineering work the standard rate applies to all sales within three years after the earlier of the certificate of completion or the first full use of the work. Standard rating does not apply to a building designed as a dwelling or a number of dwellings, or to an RRP or RCP building. The grant of a major interest (freehold or lease of over 21 years) in a dwelling, RRP or RCP building is zero-rated. Zerorating is subject to a number of conditions in the case of RRP and RCP buildings. (There is a definition of RRP buildings in Chapter 10.) Where a new building is mixed, eg a shop with a flat above, standard rating only applies to the shop. It is therefore necessary to apportion the sale price.
Definition of an RCP building An RCP building is a building for use by a charity for a non-business purpose, e.g. where charities are supported by grants and donations or as a village hall or similar, providing social or recreational activities for a local community. The term business is widely drawn and includes activities which do not make a profit. An analysis of non-business activities of a charity and the concept of a ‘village hall or similar’ is outside the scope of this report.
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Gaming and fishing rights The grant of any interest, right or licence to take game or fish is standard rated. However, standard rating does not automatically apply to the sale of freehold land containing gaming or fishing rights. Where a landowner grants or transfers the freehold of land over which the right to take game or fish is excisable, the supply of the land is exempt (subject to the option to tax). An apportionment to the sale price has to be made when land is transferred and the right to take game and fish is valuable.
Hotel accommodation The provision in a hotel, inn, boarding house or similar establishment of sleeping accommodation, or accommodation in rooms which are provided in conjunction with sleeping accommodation or for the purposes of supply of catering is standard rated.
Reduced rate Where guests stay for a continuous period of four weeks or more, VAT is chargeable on a reduced value from the 29th day. The effect is that from the 28th day, VAT has to be accounted for on a minimum of 20% of the total charge for the room and facilities. VAT remains due on meals, drinks and service charges. The charge for the room and related facilities can be reduced by excluding the value of the right to occupy the accommodation. However, the value ascribed to the facilities must not be less than 20% of the total amount due for facilities and accommodation. Hotel providers frequently make the mistake of including the reduction in value in the total of exempt income. The difference in value is not exempt so by itself does not give hoteliers any partial exemption problems.
Similar establishment Similar establishment includes premises held out as being suitable for use by visitors or travellers, which contain sleeping accommodation, whether or not there is provision of board or facilities for the preparation of food. The vague term ‘similar establishment’ has lead to a number of disputes between taxpayers and Customs, particularly in establishments providing shelter for the homeless, hostels and student accommodation. The question a tribunal frequently has to answer is whether the establishment concerned is in competition with hotels, inns etc.
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Leasing/licensing hotel buildings The exception from exemption does not apply to leases or licences of hotel buildings. If H plc lets a hotel to O plc and O plc operates the hotel, the supply by H plc is exempt (subject to the option to tax). O plc will make taxable supplies of hotel accommodation to users.
Holiday accommodation The grant of any interest in, right over or licence to occupy holiday accommodation is standard rated. This includes any accommodation which is held out as holiday accommodation or is suitable for holiday or leisure use. Standard rating does not apply to the grant of a freehold or a lease for a premium in a building held out for holiday accommodation which is not a new building (i.e. the building is more than three years old). Payment for the purchase of the freehold or premium for a lease in ‘old’ holiday accommodation is exempt.
Dwelling or holiday accommodation Difficulties can arise in deciding whether or not a new building is a dwelling or holiday accommodation. In this context it is necessary to consider the VAT Act 1994 Group 5. Item 1 (a) (i) of Group 5 zero rates the first grant of a major interest in a dwelling. However, Note (13) to Group 5 reads as follows: ‘The grant of an interest in, or in any part of: 1.
A building designed as a dwelling or a number of dwellings; or
2.
The site of such a building.
It is not within item 1 (ie it is not zero-rated) if: i)
The interest granted is such that the grantee is not entitled to reside in the building, or part, throughout the year; or
ii)
Residence there throughout the year, or use of the building or part as the grantee’s principal private residence is prevented by the terms of a covenant, statutory planning consent or similar permission.’
The consequence of the note is that the grant of a freehold or a lease over 21 years by a person constructing a new dwelling is subject to VAT at the standard rate if the grantee is not entitled to reside in the building or part of the building throughout the year.
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The case of Barbara Ashworth Whether or not ‘restricted occupancy’ means that the grant of a major interest in a new building is standard, rather than zero rated, has been the subject of a number of disputes between taxpayers and Customs. There was an important victory for the taxpayer in the case of Barbara A Ashworth (LON/94/221). The appellant owned a long lease in a waterside lodge at a Marina. The lease prohibited occupancy of the lodge during the month of February. The appellant occupied the lodge as her home for the rest of the year. The VAT tribunal decided that the discontinuing nature of the appellant’s leasehold interest did not place the property in the same category as a hotel or similar accommodation. The supply was exempt rather than standard rated.
Customs’ change of view Following the tribunal’s decision, Customs changed their view of the liability and their current opinion is set out in leaflet 709/3/93. The relevant extract is as follows: ‘However, the sale or lease of a flat or house which can be used as a person’s principal private residence but which cannot be occupied throughout the year due to a time break or restriction on occupancy is exempt, if the development on which it is situated is not a holiday development and it is not advertised or held out as such. This also applies to any periodic charges such as rent and service charges.’
Caravan and tent pitches or camping facilities The provision of seasonal pitches for caravans and the grant of facilities for caravan parks are standard rated. A seasonal pitch is a pitch which is provided for less than a year, or is provided for more than a year but where there is a restriction on occupation. The provision of pitches for tents or camping facilities is also standard rated.
Parking facilities The grant of facilities for parking vehicles is standard rated. There is normally a standard rated supply of parking facilities if a specific grant is made and facilities are designed for, or provided specifically for, the purpose of parking vehicles.
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The case of Trinity Factoring Services Limited In the case of Trinity Factoring Services Limited (CS 1994) (SDC504) the Court decided that rent for garages which are let and used to store goods was still liable to VAT at the standard rate. The Court of Session held there was a plain implication the garages were for parking, and if the terms of the letting did not actually preclude parking the supply was standard rated.
Customs’ views Customs’ views on the VAT liability of car parking are contained in leaflet number 701/24/92. In particular it should be noted that the sale of a new dwelling together with garage or parking space by the person constructing that dwelling is normally zero-rated, unless it is standard-rated holiday accommodation.
Letting in conjunction with dwellings The letting of garages or parking spaces in conjunction with the letting of dwellings for residential use is exempt provided: •
the garage or parking space is reasonably near to the dwelling; and
•
the letting is by the same landlord to the same tenant, whether under a single agreement or separate agreements.
Sales of garages etc Freehold sales of new or partly completed garages, car parks or car parking facilities other than in conjunction with the sale of new dwellings is standardrated. The freehold sales of garages, car parks or parking facilities which are not new are exempt (with the option to tax).
Provision in conjunction with commercial premises Where garages or other parking facilities are provided in conjunction with the letting of commercial premises the supply is treated as a single supply of the commercial premises, provided: •
the facilities are within or on the property or reasonably near to it; or
•
the facilities are within a complex; and
•
both lettings are to the same tenant by the same landlord.
The consequence therefore, is if the rents from commercial premises are exempt, the parking facilities will also be exempt.
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2 VAT L I A B I L I T Y O F C O M M E R C I A L P R O P E R T Y T R A N S A C T I O N S
Sports facilities The grant of facilities for playing any sport or participating in any physical recreation is standard rated. This will not apply where the grant of the facilities is for: •
a continuous period of use exceeding 24 hours; or
•
a series of ten or more periods, whether or not exceeding 24 hours in total, where certain conditions are satisfied.
Conditions for exemption The conditions under which lettings for more than ten periods qualify for exemption are: •
that each period must be in respect of the same activity carried on in the same place;
•
the interval between each period is not less than one day and not more than fourteen days;
•
the consideration is paid by reference to the whole series and is evidenced by written agreement;
•
the grantee has exclusive use of the facilities; and
•
the grantee is a school, club, an association or an organization representing affiliated clubs or constituent associations.
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Chapter 3 Land and licence to occupy land Definition of land .................................................................................20 Buildings...............................................................................................20 Scope of the exemption for land and buildings ...............................21 Immovable property............................................................................21 Licences to occupy...............................................................................22 Licence to use facilities........................................................................23 Customs’ examples ..............................................................................24
Chapter 3 Land and licence to occupy land
Definition of land As the exemption applies to grants of interests in or rights over land, it is important to define what constitutes land. The Interpretation Act 1978 defines land as including ‘buildings and other structures, land covered with water, and any estate, interest, easement, servitude or right in or over land’. The guidance from Customs states that land includes ‘any structures and natural objects to the land, so long as they remain attached’. Land therefore includes bare land, buildings and civil engineering works.
Buildings It should be noted that the VAT Act 1994 does not refer to ‘commercial buildings’. This term is used to cover anything that does not fall into any of the categories that attract special treatment, ie standard or zero rating. Standard rating applies to the exceptions to the exemption mentioned in Chapter 2. Zerorating applies to new dwellings which are defined as any self-contained living accommodation, without internal access to or from another dwelling, and includes houses and flats. Zero-rating also applies to RRP and RCP buildings. The grant of a lease in a commercial building or civil engineering work is an exempt supply, subject to the election to waive exemption, commonly known as the option to tax. The option to tax is explored in Chapter 4. The freehold sale of an ‘old’ commercial building or civil engineering work, ie more than three years after the date of completion, occupation (building) or use (civil engineering work) is exempt, subject to the option to tax.
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Scope of the exemption for land and buildings The exemption covers land and anything fixed to the land. However, exemption does not necessarily apply to the sale or letting of loose items. In exempting the supply of land, Article 13B (h) of the 6th Directive uses the word ‘land’ but does not elaborate on this or give any definition other than referring to ‘land which has not been built on’. The exemption in Article 13B (g) for the supply of buildings covers ‘or parts thereof’ and ‘the land on which they stand’. Article 4.3 of the 6th Directive states that a building shall be taken to mean any structure fixed to or in the ground. The approach under English land law and the European Directive are different. In English land law, a building or fixed structure would normally count as part of the land and be owned with it. In some European countries, it is possible to own a building without having interest in the land on which it stands. English land law differentiates between fixtures and fittings. A fixture is regarded as part of the land whilst a fitting is not. For practical purposes Customs has accepted that fixtures fall within the land exemption. Fittings, if they are subject to a separate supply do not, but the borderline is not always entirely clear.
Immovable property The leasing and letting exemption is contained in Article 13B (b) of the 6th Directive. This Article does not use the word ‘land’ at all but refers to immovable property. There is no definition of immovable property in the Directive, but the Directive does give specific exclusions for ‘permanently installed equipment and machinery’. There is therefore a difficulty in establishing whether something is ‘immovable’ and exempt under the European 6th Directive. Two cases of note are Commission v France (CJEC Case C-60/96) and Rudolph Maierhofer (CJEC Case C-315/00).
The case of Commission v France The ECJ held that immovable property did not cover touring caravans, tents, mobile homes and light-framed leisure dwellings that were fixed to the ground.
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The Court decided that these were movable since they were capable of being easily moved. Despite the Commission v France case, the UK continues to treat the letting onsite of residential caravans and houseboats as exempt.
The case of Rudolph Maierhofer In the Rudolph Maierhofer case, and apparently in contrast to the France decision, the ECJ held that temporary buildings were immovable property. Although the buildings could be dismantled and moved, the process was very labour intensive and time consuming. The Rudolph Maierhofer case is also interesting for the fact that Herr Maierhofer had no interest in the land on which the buildings stood. The ECJ, when giving its judgement, said that it was irrelevant whether the letting was of both the land and the building, or of just the building built on the lessee’s land; it was enough for the property to be immovable. The UK’s view remains that the lessor does need an interest in the land to come within the exemption. The ECJ decided that immovable property did not have to be fixed to or in the ground, and it was irrelevant that buildings would be removed at the end of the lease and re-used elsewhere. The ECJ clearly stated that the meaning of ‘immovable property’ could not be determined in terms of the civil law of a particular member state.
Licences to occupy Defining a ‘licence to occupy’, as opposed to a licence to use land, is important as transactions which fall short of licences to occupy are standard rated. Customs have made many attempts to review the meaning of ‘licence to occupy’ within the scope of the UK and EU exemption. There has been a raft of case law in recent years.
The case of Sinclair Collis One significant case which seemed to go on forever is Customs & Excise v Sinclair Collis Ltd (C-275/01). This case progressed from the VAT tribunal to the Court of Appeal and on every occasion the decision was reversed. The case was appealed to the House of Lords who decided to refer the question of the VAT liability to the European Court.
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Sinclair Collis owned cigarette machines and installed machines in public houses. The question was whether or not the supply by the site owner in agreeing to the installation of a cigarette machine in a pub was a supply by the site owner of the letting of immovable property. The ECJ decided that the agreement between the site owner and Sinclair Collis did not constitute a ‘letting of immovable property’ within Article 13B (b) of the Sixth Directive. The ECJ stated that the fundamental characteristics of a leasing or letting of immovable property within Article 13B (b) are that the leasing or letting: •
related to immovable property (firmly fixed to or in the ground);
•
was a right to occupy a particular property;
•
confered a right to control access or exclude any other person;
•
as if the person were the owner, for an agreed period and for payment.
In the case of Sinclair Collis, the ECJ saw the occupation of space as merely a way of affecting the real supply which was the grant of the exclusive right to sell cigarettes on the premises.
The case of Abbotsley Golf & Squash Club In an earlier case, Abbotsley Golf & Squash Club (VTD 15042), Customs attempted to sustain an argument that the supply of a licence granted to the golf and squash club operator to use the land and clubhouse was non-exclusive (as members of the public have access) and was therefore not exempt. The tribunal held that the licence was a lease in all but name and was within the meaning of ‘leasing and letting’ of land.
Licence to use facilities A licence to use facilities is a taxable supply as it falls short of the exemption for a ‘licence to occupy’. This can afford some flexibility and a means of obtaining recovery of VAT on related costs where the option to tax is not available. Care is required however, and businesses have to be wary of Customs drive on avoidance (Chapter 9).
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Customs’ examples Customs gives examples of licences to occupy land in its Notice 742. The following is an extract from Notice 742 which was last amended in December 2003, following the decision in Sinclair Collis:
Licences to occupy •
The provision of office accommodation, such as a specified bay, room or floor together with a right to use shared areas such as receptions, lifts, restaurants, rest rooms, leisure facilities and so on.
•
The provision of a serviced office that includes use of telephones, computer system, fax machine, photocopiers and so on.
•
Granting a concession to operate a shop within a shop, where the concessionaire is granted an area from which to sell their goods or services.
•
Granting space to erect advertising hoardings.
•
Granting space to place a fixed kiosk on a specified site, such as a newspaper kiosk or flower stand at a railway station.
•
Hiring out a hall or other accommodation for meetings or parties and so on. Use of a kitchen area, lighting and furniture can be included.
•
Granting a catering concession where the caterer is granted a licence to occupy a specific kitchen and restaurant area, even if the grant includes use of kitchen or catering equipment.
•
Granting traders a pitch in a market or at a car boot sale.
No licence to occupy Customs see the following as not being licences to occupy and therefore subject to VAT: •
Sharing business premises where more than one business has use of the same parts of the premises without having their own specified areas.
•
Providing another person with access to office premises to make use of facilities, such as remote sales staff away from home having access to photocopiers and the like at another office.
•
Allowing the public to tip rubbish on your land.
•
Storing someone’s goods in a warehouse without allocating any specific area for them.
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•
Granting of an ambulatory concession, such as an ice-cream van on the seafront or hamburger van at a football match.
•
Allowing the public admission to premises or events such as theatres, historic houses, swimming pools and spectator sports events. This included admission to a series of events such as a season ticket.
•
Any grant of land clearly incidental to the use of the facilities on it, such as hiring out safes to store valuables, the right to use facilities in a hairdressing salon or granting someone the right to place a freestanding or wall mounted vending or gaming machine on your premises.
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Chapter 4 Option to VAT Introduction..........................................................................................27 Why opt? ..............................................................................................27 Commercial considerations................................................................27 Interaction with stamp duty land tax ................................................28 Option ineffective ................................................................................28 Scope of an option to tax ....................................................................29 Who can opt? .......................................................................................30 How is the option exercised? .............................................................32 Option to tax – national unit...............................................................33 Problems with notifications/acknowledgements .............................34 Adding VAT to rents............................................................................34 Informing tenants ................................................................................35 Subsequent works ...............................................................................35 Is an option valid?................................................................................36 Permission to opt regime....................................................................37 Revocation of an option ......................................................................41
Chapter 4 Option to VAT
Introduction Making an election to waive exemption, commonly known as exercising an option to tax allows vendors or landlords to charge VAT at the standard rate on what would otherwise be exempt transactions. Subject to a number of conditions and exceptions any person can opt to tax land or commercial buildings. Following the exercise of an option VAT becomes chargeable on all future income from exploitation of the property, including final disposal.
Why opt? Taxpayers are normally reluctant to charge VAT, so why would anyone voluntarily exercise an option to tax. The three most common reasons for opting to tax are: •
to recover VAT on costs that would otherwise be irrecoverable because the costs would relate to exempt supplies (see Chapter 6);
•
to ensure that the purchase of an opted property and the acquisition of the freehold in a ‘new’ commercial building can be treated as the transfer of a going concern (Chapter 8);
•
to avoid a clawback of VAT under the Capital Goods Scheme rules (Chapter 7).
Commercial considerations Consideration should always be given to the commercial consequences of opting. For example, the state of the property market in the area concerned, or whether the tenant or purchaser will be able to recover the resulting VAT charges.
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The VAT considerations include: •
How much VAT is at stake?
•
Is recovery of VAT possible anyway by virtue of the partial exemption de minimis rules (chapter 6 refers)?
•
If you are not already VAT registered can your system cope with the requirements of VAT registration?
•
Would the VAT saved by opting be outweighed by additional stamp duty land tax?
Interaction with stamp duty land tax Stamp duty land tax (SDLT) is payable by the purchaser on the VAT inclusive consideration for any land or property transaction. Charging VAT therefore increases the amount of SDLT payable. It may be considerably cheaper for a purchaser to pay the vendor’s irrecoverable VAT rather than pay say an additional 4% on 17.5%. The SDLT position could be even worse if the inclusion of VAT in the consideration means the band of SDLT increases (SDLT ranges from 1% to 4% depending on the value of the property).
Option ineffective The option to tax is not effective i.e. it is disapplied, in the following circumstances: •
A building intended to be a dwelling or a number of dwellings. However, the VAT legislation allows the option to remain effective if it relates to a commercial building that is intended to be converted to a dwelling or dwellings, provided the purchaser will ultimately use the property to make zero-rated supplies. Both parties must agree to the retention of the option in writing.
•
A building (or part of a building) intended for use solely for a relevant residential purpose.
•
A building (or part of a building) intended for use solely for a relevant charitable purpose otherwise than as an office.
•
Where a grant is to be made by a developer and it is the intention or expectation of the developer that the land will become exempt land (this is an anti-avoidance provision, see Chapter 9).
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•
Where land is supplied to a registered Housing Association for house building or when a plot is supplied to an individual who intends to build a dwelling for himself on the site.
•
The supply of a pitch for a residential caravan or facilities for mooring a houseboat.
The definitions of relevant residential and relevant charitable purpose are described in Chapter 10 and Chapter 2 respectively.
Scope of an option to tax The option to tax can be exercised in respect of any land, non-residential building or civil engineering work. As far as buildings are concerned, the option can be exercised on a building by building basis. It is not possible to opt on only part of a building. Buildings/units linked either by a common roof or by a covered walkway are regarded as single buildings. A complex is treated as a single building if it consists of a number of units grouped around a fully enclosed concourse, such as an enclosed shopping precinct. Options could be made on parts of buildings or buildings which are part of a complex by transferring the buildings to separate ownership. This decision is of course subject to other tax and commercial considerations.
Discrete areas of land The option extends to all the land, and any buildings or civil engineering works which are part of the land. It is possible to opt on discrete areas of land provided the area is specified to Customs. The option on a discrete area will not affect any adjoining land. An option extends to land immediately around the opted building such as forecourts, yards etc.
Customs’ guidance Defining and agreeing with Customs exactly what the option covers can be a difficult issue and where there is doubt as to the geographical extent of an option the vendor or landlord is advised to discuss the matter and agree the extent of the land being opted with Customs. In their public notice 742A Customs give the following guidance on the extent of an option: ‘If the building stands in a large area of land, how far the option extends over the land depends on how far the services of the building can be utilised.
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For example, a racecourse grandstand may provide electricity and shelter for stalls, or other facilities, within its peripheral area. An option to tax on the grandstand would extend over the whole area of land that uses the benefits.’
Who can opt? The option to tax is personal to the person making the option. The option does not bind any other person, including successors in title. Any successor can make his or her choice as to whether to exercise the option to tax. In practice a successor will normally be conditioned by the nature of the supply to him or her. If VAT has been charged on the acquisition of the interest it will generally be worthwhile opting to avoid otherwise irrecoverable VAT.
VAT groups There are special rules for VAT groups. Where an option is exercised by an individual member of a VAT group, the option to tax binds the member notifying the option and all other members of the VAT group, both at the time of notification and in the future. The effect of this rule is that an option applies and extends to the VAT group as a whole. This can be illustrated by an example: A and B are members of a VAT group. A opts to tax a property which it owns and the option also binds B. Subsequently, C joins the VAT group and the option made by A also binds C.
Partnerships Where land is held by a partnership or in trust there can be difficulties in deciding who should exercise the option and register for VAT. The option should be exercised by the beneficial owner, not the legal owner. If there is more than one beneficial owner, the owners will be expected to opt as one person and to register for VAT as a partnership. For UK limited partnerships, it is the general partner who should opt. Where there is more than one general partner the general partners should opt together as a partnership. For any other type of partnership, including a limited liability partnership (which is a corporate body rather than a partnership), the body should opt as one entity.
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Joint ventures Particular care is needed with joint ventures. There are various ways of handling joint venture situations when it comes to registering and opting. The permutations can be explained by an example:
Paul and Simon enter into a joint venture with Simon retaining ownership of the land. 1.
The agreement of Customs could be obtained to: •
Simon issuing the VAT invoice to the purchaser in his (Simon’s) name;
•
Simon and Paul making options on the property;
•
Paul accounting for VAT on half the sale proceeds and recovering VAT on half the costs paid to third party contractors.
2.
Simon invests half the beneficial interest in the property to Paul. Under this route: •
Simon will issue the invoice in his name but half the invoice figure was issued as nominee for Paul;
•
Paul will account for half the output tax and claim half the VAT on costs;
It would be prudent to obtain Customs permission and both would have to opt. 3.
If the land is owned jointly beneficially then both could opt with Simon holding the legal interest. In strict law two invoices would have to be issued to the purchaser to reflect VAT on the wholesale proceeds. As far as VAT recovery is concerned, Simon will have employed the contractors and is the only one who can recover VAT. However, Simon will have made a supply to Paul when recharging half the costs. Simon accounts for output tax with Paul recovering the VAT charged as input tax. Alternatively, Simon issues the sale invoice but Paul charges VAT to Simon on his share of the proceeds. Again, it is important to agree the procedure with Customs.
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VAT registration and ownership necessary? It is not strictly necessary for the person opting to tax to be registered for VAT, nor is it necessary for the person opting to have a legal interest in the property. Although Customs acknowledge this fact in their Notice 742A, in practise, Customs refuse to process an option exercised by someone who has neither interest in the land nor any plans to acquire an interest. This can cause considerable difficulties and time delays. Customs’ attitude can be particularly frustrating when needing to register and notify in advance of completion, e.g. when trying to comply with the transfer of going concern conditions (Chapter 8).
How is the option exercised? Opting to tax is at least a two-stage process and there can be three stages.
Decision to opt Firstly, there is the act of opting itself. It is not always clear what constitutes an option. It is preferable and useful to have written evidence of an option, such as a Board Minute. However, opting can be merely an unspoken decision.
Notification The second stage is that once an option has been made then, in order for the option to be effective, the option has to be notified to Customs within 30 days of the decision to opt being taken.
Permission to opt There is an interim stage which occurs where Customs’ prior permission for an option is necessary. Prior permission is necessary when the person making the option has previously made exempt supplies in the property concerned. If prior permission is necessary, permission must be obtained before notifying an option. The permission regime is explored further below.
Effective date An option can take effect from a current date or from any future date agreed with Customs. An option cannot be retrospective. However, Customs will normally accept belated notifications if the person concerned has been charging VAT as though an option had effect.
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How to notify Once an option has been exercised, an option should be notified to Customs within 30 days. Failure to notify Customs of an option may mean that the option is ineffective. Following the case of Chalegrove Properties Limited (VTD17151) Customs accept that, where notification is by post, it is sufficient for the notification to have been properly addressed, prepaid and posted to them. It is therefore important to retain any certificate of posting.
Form of notification There is a form VAT1614 for notifying options to tax. The form is obtainable from the Customs’ website at www.hmce.gov.uk or from the Customs’ national advice service on 0845 0109000. Use of the form VAT1614 is not mandatory, and it is possible to notify an option by letter, fax or email, provided the notification contains the following information: •
Name, address and VAT registration number (if any) of the person opting to tax.
•
A description of the property (it is important that the property is identified, therefore include full address, postcode, together with marked plans (if appropriate)).
•
The effective date of the option.
In addition, the notification should state whether or not any previous exempt supplies have been made. If so, permission to opt from Customs may be required.
Option to tax – national unit Until 2003 options had to be notified to the local VAT office. In 2003, Customs opened a national unit in Glasgow. The address of the national unit is: Option to Tax National Unit, HM Customs & Excise, Portcullis House, 21 India Street, Glasgow, G2 4PZ. This office now deals with all options to tax.
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The national unit normally acknowledges receipt of notifications. Prior to the opening of the national unit, Customs did not automatically acknowledge receipt of notifications. Whether or not an acknowledgement was automatically issued depended on the practise of the local office concerned. The inconsistency by Customs has created difficulties for business.
Problems with notifications/acknowledgements When an opted property is sold, solicitors normally ask for a sight of the vendor’s option notification and acknowledgement from Customs. Particularly in the early days of the option to tax regime insufficient attention was paid to notification, acknowledgement and recording of options by both Customs and businesses. It is fairly common that the vendor has nothing in writing from Customs and, sometimes, neither Customs nor the vendor can trace the notification. If Customs have a notification on file they will provide the information to the vendor on request. Where there is no notification on file, Customs standard response is that this does not automatically mean that the vendor has not opted. If the vendor has previously been charging VAT on rents but has no record of the notification, it can be prudent to write to Customs asking them to accept belated notification (if Customs have no record themselves of an option).
Adding VAT to rents The option applies to future transactions from the effective date. Rents reserved under a lease will become taxable. VAT can be added to agreed price or rent unless the sale agreement, lease etc specifically provides otherwise. Section 89 of the VAT Act 1994 allows VAT to be added to otherwise exempt rent, following an option notification. As the tax point, ie the date VAT is due, is the earlier of date of tax invoice or payment, any rent due before the effective date but paid after the effective date, will be subject to VAT. Care is required therefore when exercising an option to ensure that there are no outstanding rent payments. If so, it may not be possible to add VAT to the payments.
Other payments The option not only applies to rents but also to payments reserved as rent in the lease. This means that service charges and other recoverable costs such as
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insurance (unless the tenant is the policyholder or party to the policy), wages, fees etc will be taxable if the rent is taxable.
Informing tenants There is no legal requirement to inform tenants when opting, but morally they should be informed. An option made by the superior landlord will have direct affect on any tenant who is sub-letting. The tenant will wish to consider whether to opt himself or potentially lose all or a proportion of VAT on the rent payable to the superior landlord.
Subsequent works If a building on which an option has been made is extended, the option will automatically cover the extension. If two buildings, one of which is opted, are knocked through to form a single building, the option applies to the whole building. However, Customs have stated that they do not see an option automatically extending where an owner constructs a linked walkway between two buildings or encloses a previously unenclosed complex. If there is any doubt and an option is required, it will be prudent to notify a fresh option. Customs’ view is based on the UK’s legislation which is different to the wording in the EU legislation. In particular, Customs’ view an option on a building as different from an option on the land on which the building actually stands. Therefore: •
If an option is exercised on bare land, the option does not automatically cover a building subsequently built on the site.
•
If an option is exercised on a building which is then demolished or destroyed, the option lapses and the option does not apply either to the site or to any new building on it.
The case of Brigitte Breitsohl Customs’ view on the above appears to be incorrect and this was highlighted by the judgement of the ECJ in a German case, Brigitte Breitsohl (CJEC Case C – 400/98 (2001 STC 355)). In the Breitsohl case the ECJ decided that an option simply applied to the land together with whatever happened to be on the land at the time a supply was made. Customs did not announce any change of policy following the decision in Breitsohl, although as stated their approach does seem
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questionable in UK law. It has to be noted however, that there are significant differences between German and UK regulations concerning the option to tax. Businesses are advised that it is safer to follow UK policy and, however administratively burdensome, notify a new option if a building is demolished and a new building constructed, or a building is constructed on bare land. The good news is the Customs view does provide businesses with some flexibility (and if the cost of demolition is commercially justified, provides a way of making an unwanted option disappear).
Is an option valid? There have been numerous cases on the question of whether or not an option is valid. Two of the most significant are:
The case of Fencing Supplies Limited In this case the company charged VAT on rent without consciously opting to tax. The property was then sold without a charge to VAT. The VAT tribunal considered that charging VAT on rent was enough to mean that the company had opted, so that VAT was also due on the sale of the property. It should be noted that at the time of this decision, the rules did not require all options to be notified. The outcome of a similar case may be different now, since to be valid, all options have to be notified to Customs. Care is required however. The author is aware of a case where a company had charged VAT on rent to subsidiary companies but had not notified an option. Customs attempted to sustain an argument that an implied option had been made by the company and assessed the company for a not inconsiderable amount of VAT. Customs took some persuading to withdraw the assessment and reference had to be made to a file note of a telephone conversation when the issue of opting had been discussed and rejected. Accordingly, the company was able to demonstrate that it never had an intention to opt.
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The case of Blythe Limited Partnership The Partnership acquired a portfolio of sixteen properties, on four of which the vendor had opted on. Although the partnership intended to opt on just the four properties, the solicitors notified Customs of an option on all sixteen. The VAT tribunal found this did not mean that the partnership had intended to opt on the other twelve, as Customs contended, as the acts of opting and notifying were separate. Following the decision in Blythe Limited Partnership, Customs issued guidance on notifying an option to tax. Customs recommend that a letter notifying an option is signed as appropriate by a director, two or more partners (or trustees), an authorised administrator or a sole proprietor. If a business authorises a third party to notify an option on its behalf, Customs require confirmation in writing that the third party is authorised to bind the business to the option.
Permission to opt regime Although mentioned in passing earlier as one of the key stages in making a valid option, the permission rules are often misunderstood and are deserving of further analysis.
Reason for permission regime Prior to 1 January 1992, no VAT on costs could be recovered if the costs were incurred prior to the effective date of an option unless the person concerned had not made any exempt supplies in the property. The permission regime was introduced by Customs to assist businesses which had made exempt supplies prior to opting in recovering VAT on costs incurred prior to the effective date of an option. Customs’ concern is to ensure that there is a fair and reasonable apportionment of VAT on costs between the future taxable and prior exempt supplies. The permission rules are used by Customs both as a facilitation measure and an anti-avoidance procedure. The rules are so complex and important that it is worth looking at Customs’ requirements in detail.
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Automatic permission There are limited circumstances where automatic permission is given by Customs. Paragraph 5.2 of Customs public notice 742A which has the force of law, sets out four sets of circumstances where permission to opt is available automatically: 1
It is a mixed use development and the only exempt supplies have been in relation to the dwellings.
2
You do not wish to recover any input tax in relation to the land or building incurred before the option to tax has effect; and •
The consideration for your exempt supplies has, up to the date when the new option to tax takes effect, being solely by way of rents or services charges and excludes any premiums or payments in respect of occupation after the date on which the option takes effect. Regular rental and/or service charge payments can be ignored for the purposes of this condition. Payments are considered regular where the intervals between them are no more than a year and each represents a commercial or genuine arms’ length value; and
•
The only input tax relating to land or building that you expect to recover after the option to tax takes effect will be on overheads, such as regular rental payments, services charges, repairs and maintenance costs. If you expect to claim input tax in relation to refurbishment or redevelopment of the building you will not meet this condition.
3
The only input tax you wish to recover in relation to the land or building before the option to tax takes effect relates solely to tax charged by your tenant or tenants upon surrender of a lease; and •
The building or relevant part of the building has been occupied between the date of the surrender and the date the option to tax is to take effect; and
•
There will be no further exempt supplies of the land or building; and
•
You do not intend or expect to occupy the land or the building other than for taxable purposes.
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4
The exempt supplies have been incidental to the main use of the land or building. For example, where you have occupied a building for taxable purposes the following would be seen as incidental to the main use and the condition would be met: •
allowing an advertising hoarding to be displayed;
•
granting space for the erection of a radio mast; or
•
receiving income from an electricity substation.
The letting of space to an occupying tenant, however minor, is not incidental. The circumstances where automatic permission is available are very narrow. For example in 2 above, it is unrealistic that a business would opt to recover VAT on general overheads with no prospect of recovering VAT on future refurbishment.
Customs’ operation of the permission regime Customs operate the permission regime very strictly and it can be very time consuming to obtain permission. Customs state in notice 742A: •
they cannot give permission for the option unless and until they have all the information required;
•
the effective date of the option cannot be before the date they give permission;
•
businesses applying for permission should give a date when they want the option to take effect, allowing Customs at least a month to consider the request; and
•
any letting etc of the property while Customs are considering the matter is necessarily exempt, so that related input tax is irrecoverable.
Information required by Customs The information Customs require to consider a request for permission to opt is extensive, Section 5.5 of Notice 742A (March 2002) gives details of the information required in the following terms: •
A brief description of your future plans for the land or building, should we grant permission to opt or tax.
•
Details of any input tax you incurred in the ten years before opting to tax that you wish to recover. We need details of the amount of input tax you wish to claim, how this has been calculated, what the input
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tax relates to and where it was incurred. You also need to give us details of any input tax that you expect to incur in the period between your request for permission and the date you wish the option to take effect. •
You also need to give us details of any input tax that you expect to incur in the period between your request for permission and the date you wish the option to take effect.
•
The value of input tax you expect to incur in the future if we grant permission to opt to tax, and what this input tax will relate to. For example rents, premiums, surrenders or refurbishments.
•
The total value of your exempt supplies for the land or building in the ten years before your request for permission. You also need to give us the value of any supplies you expect to make between the date of your request for permission and the date the option is to be effective. We need details of any grants you have made for a premium or repayment of rent, including the dates they were made, their values and the period to which they relate.
•
The expected value of the taxable supplies you intend to make in the foreseeable future after the date of your option to tax, should we grant permission. Where these taxable supplies are the result of the granting of standard-rated leases you should advise how long leases already in place are expected to run, if you have any reason to suspect they will not run their full course. You should indicate whether you are likely to make any exempt grants after your option to tax takes effect, for example supplies where the option to tax will not apply for any reason.
•
Whether you or anyone who has helped to fund the land or building, or anyone connected to you or the financier is occupying or intending to occupy any part of the land or building.
Obtaining all the information can be an onerous task. Customs are also likely to respond by asking further questions. Businesses should allow ample time to obtain permission. Although in normal circumstances Customs rarely refuse permission their approach is inflexible with little or no regard for the commercial realities. The permission rules seem to be too restrictive. The sheer weight of information is off-putting. Businesses will frequently forego their entitlement to VAT recovery in order to facilitate an option, particularly when time is pressing. In
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certain circumstances it can be beneficial to transfer a property to a subsidiary and have the subsidiary opt. Even where a business qualifies for automatic permission the business still has to notify Customs that it qualifies for automatic permission. Failure to inform Customs of qualification for automatic permission when notifying an option could render the option invalid.
Proposal for change to permission regime In 2003, Customs issued a consultation document on the recovery of input tax. No meaningful changes have been introduced as a result of the consultation but hopefully Customs will have another look at the permission rules. The proposals in the consultation document for automatic permission are that automatic permission should be available if: •
the person is registered for VAT;
•
the person expects to make only taxable supplies of land and buildings;
•
they are only going to reclaim input tax if the input tax was incurred post election or pre-election input tax can be reclaimed using the Capital Goods Scheme;
•
no untaxed premiums or advanced payments have been received; and
•
the building will not be used for ineligible purposes.
The proposal would simplify matters and will hopefully be adopted at some stage.
Revocation of an option Once made, an option is normally irrevocable There are limited circumstances in which an option can be revoked. There is a ‘cooling off’ period of three months from the date on which an option was made. It is necessary to obtain Customs’ consent. Revocation is not permitted if tax has become chargeable or VAT has been reclaimed as a result of the option, i.e. where the option has been put into practical effect. An option can also be revoked, with the consent of Customs, after 20 years have passed from the date the option was made. As the first options were made in 1989, the first revocations will occur in 2009. Customs have issued a consultation document and the issue is outlined in Chapter 11.
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Chapter 5 VAT on transactions relating to leases Introduction..........................................................................................43 Lease surrenders..................................................................................43 Variation of the terms of a lease ........................................................44 Reverse premiums ...............................................................................44 Assignment of a lease .........................................................................45 Dilapidation payments ........................................................................46 Rent free periods .................................................................................46
Chapter 5 VAT on transactions relating to leases
Introduction The extensive and fundamental changes to the VAT on property legislation in 1989, meant that the VAT liability of numerous payments between landlords and tenants had to be considered. Some sixteen years later, a number of the issues have not yet been resolved. This chapter looks at the VAT liability of certain common payments between landlord and tenant, and tenant and landlord.
Lease surrenders Where a tenant surrenders his or her lease to a landlord and the landlord pays the tenant for the surrender, this supply is an exempt transaction by the tenant. No VAT is chargeable unless the tenant has opted to tax the property concerned. The leading case is Lubbock Fine & Co v The Commissioners (1994) STC 101. Lubbock Fine surrendered the lease of its offices to its landlord in return for a payment. At that time the legislation exempting property transactions made no mention of surrenders. Customs assessed for VAT. The case was referred to the ECJ who decided the transaction was exempt under Article 13B of the Sixth Directive. The UK law was changed. It is the tenant who is making the supply and whether or not VAT is applicable depends on the status of the tenant, i.e. whether the tenant has opted. The landlord’s VAT position is not relevant to the liability.
Reverse surrenders Where a tenant pays a landlord to accept the surrender of a lease (referred to as a reverse surrender), there is a supply by the landlord. Reverse surrenders are specifically included within the exemption in UK legislation (Note 1 and Note 1(A) to the VAT Act 1994, Sch 9, Group 1, Item 1). The UK legislation was amended
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in 1995 following Lubbock Fine. Recent decisions of the ECJ have thrown doubt on whether the UK’s legislation is correct. In a case involving a Dutch housing association, Stichting Goed Wonen (CJEC Case C-326/99), the ECJ took the view that the leasing or letting of immovable property must: •
relate to immovable property;
•
confer the right to occupy property as if the person were the owner;
•
confer a right to exclude anyone else from enjoyment of the right to occupy;
•
be for an agreed period; and
•
be in return for payment.
The surrender of a lease falls within the above definition as the tenant is granting to the landlord the right to occupation of the property unencumbered by the lease. It is difficult to see a reverse surrender falling within the definition as the landlord (who is making the supply) is not conferring an interest in land. It is possible that the UK may have to withdraw the exemption at some stage but for the moment, businesses can rely on the UK legislation.
Variation of the terms of a lease If a tenant pays a landlord to agree to a variation of the terms of a lease, the landlord is making a supply. Customs changed their view on the VAT liability of payments to vary lease terms following the decision in Lubbock Fine. Any such payment is additional consideration payable for the land interest and the VAT liability of the landlord’s supply follows that of the lease, i.e. exempt but subject to the option to tax. As with reverse surrenders there is some doubt as to whether or not the UK is correct.
Reverse premiums As can be seen in the previous paragraph, the VAT liability of payments by landlords to tenants can be difficult to determine. It was hoped that the case of Mirror Group plc (CJEC Case C-98/98 (2001) STC 1453) would clarify matters but the decision of the ECJ and the reaction by Customs to the decision, appears to have made the issue more confusing.
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The case of Mirror Group Mirror Group took a lease in Canary Wharf and received an inducement payment from the landlord. The ECJ decided that the supply could not be exempt as the supply was not leasing and letting. However, the issue was raised as to whether or not the Mirror Group had made a supply at all. The ECJ’s opinion was that in the circumstances the Mirror Group had made a supply by agreeing to become an anchor tenant. They agreed that the supply was one of advertising services as the presence of Mirror Group would attract other tenants to the building. The current difficulty in the UK is that only a small minority of tenants are anchor tenants. The ECJ stated in its judgement in Mirror Group that: “A taxable person who only pays consideration in cash due in respect of a supply of services, or who undertakes to do so, does not himself make a supply of services…It follows that a tenant who undertakes, even in return for payment from the landlord, solely to become a tenant and to pay rent does not, so far as that action is concerned, make a supply of services to the landlord.” The above statement appears to be unambiguous but has not been accepted by Customs. Their view is the statement should be interpreted narrowly as only applying where a tenant takes a lease and agrees to pay rent. Where the tenant agrees to be bound by other terms in the lease and receives a payment, the payment is taxable. This seems nonsensical as there will be terms in all leases which a tenant will be bound by. It is known that Customs have conceded in a number of recent disputes before the disputes reached a VAT tribunal. It seems at some stage they will be forced into a policy change.
Assignment of a lease If an incoming tenant is paid to accept an assignment of a lease by an outgoing tenant, there is a standard rated supply by the new tenant to the old tenant. This was confirmed by the ECJ in Cantor Fitzgerald (CJEC Case C-108/99, (2001) STC 1453). Interestingly, the case cast further doubt on the UK’s treatment of reverse surrenders. Cantor Fitzgerald International argued that its supply in taking an assignment was exempt and referred to the decision in Lubbock Fine where exemption was allowed due to ‘a change in the contractual relationship between landlord and tenant’. This argument was rejected by the ECJ who relied
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on the definition of leasing and letting in Stichting Goed Wonen, referred to above. It appears that Lubbock Fine produced the right result (exemption) but for the wrong reasons.
Dilapidation payments The terms of a lease may provide for the landlord to recover from the tenants, on termination of the lease, an amount to cover the cost of restoring the property to its original condition. Any dilapidation payment represents compensation and is not consideration for a supply of services. The payment is outside the scope of VAT.
Rent free periods The grant of a rent free period is not a supply for VAT purposes. This is provided the rent free period is not in return for the tenant agreeing to do something of benefit to the landlord, e.g. carrying out works to the property. If the tenant does so agree and the landlord has opted to tax, VAT is due on the amount of rent foregone. There could also be a supply by the tenant in the above circumstances. The tenant would have to account for VAT on the value of the obligations assumed under the agreement.
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Chapter 6 Calculating recoverable VAT in the property sector Introduction..........................................................................................48 Partial exemption.................................................................................48 Standard partial exemption method .................................................49 Annual adjustment ..............................................................................49 Special methods...................................................................................50 Partial exemption de minimis limits ..................................................51 VAT recovery – change of use ............................................................51 Abortive and speculative developments ...........................................52 Recovery of VAT prior to an option to tax........................................52
Chapter 6 Calculating recoverable VAT in the property sector
Introduction Property investors and developers normally make both taxable and exempt supplies. Therefore, many are what are known as partly exempt. All property investors and developers need to consider whether any of the VAT on costs incurred is recoverable and, if so, what the best method of determining recoverable VAT is.
Partial exemption VAT on costs is only recoverable if the costs are incurred in relation to taxable supplies and VAT is not recoverable if the costs are incurred in respect of exempt supplies. VAT on costs which cannot be attributed to either taxable or exempt supplies is partly recoverable. If a business is partly exempt, its recovery of VAT on partly recoverable costs has to be calculated by using a partial exemption method. Determination of recoverable VAT involves the direct attribution of VAT to taxable supplies on the one hand, and to exempt supplies and non-taxable activities on the other. It is, therefore, necessary to use an accounting system which identifies, at the earliest possible stage, those costs which can be regarded as wholly attributable to taxable supplies and those costs which are wholly attributable to non-taxable or exempt supplies.
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Standard partial exemption method Once the costs have been attributed to taxable and non-taxable activities, the recoverable proportion of VAT on the remaining VAT (residual input tax) can be determined in a number of ways. The only method which can be used without the approval of Customs is what is known as the standard method. The standard method calculates recoverable VAT in the ratio of the value of taxable supplies to the value of all supplies of the business concerned. Residual input tax x Value of taxable supplies Value of total supplies
The fraction should be expressed as a percentage and rounded up to the next whole number. If the ratio of taxable supplies to total supplies is 59.1%, 60% of the residual input tax is recoverable. The calculation must be made for each VAT accounting period. The amount of VAT deducted on a monthly or quarterly basis is provisional. Customs maintain that the standard method has been exploited by a number of larger businesses. To counter the exploitation Customs introduced over-ride provisions effective from 1 July 2002. Businesses are required to adjust the VAT recoverable at the end of the year if the amount based on the ratio of income is substantially different from an attribution based on use of the costs. Substantially, means more than £50,000 or more than half the total of residual VAT, but more than £25,000. The measure should only affect the minority of businesses.
Annual adjustment At the end of each VAT year the provisional VAT recovered has to be adjusted. A VAT year is to the end of March, April or May depending on the VAT return periods of the business concerned. It is possible to agree a VAT year with Customs, e.g. to coincide with a businesses financial year. The calculations are reworked using the values and VAT for the whole VAT year. The annual adjustment compares the result to the VAT recovered during the four (or twelve if the business is on monthly returns) individual VAT periods. The business then either repays or claims VAT, depending on whether the VAT calculated using the annual figures is higher or lower than the VAT actually recovered.
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The main purpose of the annual adjustment is to iron out any seasonal fluctuations or variations in spending patterns.
Special methods If businesses (or indeed Customs) consider that the standard method does not give a fair and reasonable result, businesses can negotiate with Customs special methods of calculating recoverable VAT. It is likely that the standard method will not be appropriate to most property companies. Examples of special methods include: •
Taxable properties as a ratio of total properties.
•
Taxable occupiable space as a ratio of total space.
•
Number of taxable transactions divided by total number of transactions.
•
Time spent on taxable transactions compared to total time spent on all transactions.
•
Taxable input tax divided by total input tax.
A business may have several different activities and it may be beneficial to use different methods of calculation for different ‘sectors’. For example, every property may be regarded as an individual sector. A sector may also encompass a cost or profit centre, an accounting or investment activity or geographical location. It is essential that a special method is agreed with Customs in writing. An agreement in writing is a legal requirement with effect from 1 April 2005. It is important to ensure that the wording of the agreement concurs precisely with the way the business intends to operate it. The agreement should reflect all of the activities of the business concerned. If there are ‘gaps’ in the method and there is no provision for dealing with certain VAT, the VAT can only be recovered to the extent that the relevant costs are actually used to make taxable supplies. All methods should be kept under review to ensure the method still meets the needs of the business. Any amendments have to be agreed with Customs.
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Partial exemption de minimis limits It is likely that many companies, especially those with a mainly taxable portfolio of properties, will be able to recover VAT in full due to the de minimis limits. Businesses can treat all VAT on costs as recoverable in any VAT return period where the VAT on costs relating directly and indirectly to exempt activities is less than: •
£625 per month on average; and
•
50% of the total VAT incurred.
Businesses whose VAT on costs relating to exempt activities is below the limits referred to above are still required to carry out and retain details of a partial exemption calculation.
VAT recovery – change of use Attribution of VAT on costs is normally made by reference to the first supply which is made using the goods or services in question. This gives scope for VAT avoidance through a change of use, but avoidance is countered in part by the Capital Goods Scheme (see Chapter 7) and by change of intention rules contained in regulations 108 and 109 of the VAT Regulations 1995. Regulation 108 applies where a business has deducted an amount of VAT because the intention was to use the cost concerned in making taxable supplies or both taxable and exempt supplies, and during the next six years and before any supply is made the business uses, or forms an intention to use, the cost only for exempt supplies. The VAT recovered has to be repaid in full if the use is exempt, or partially repaid where a dual (taxable and exempt) use is made of the cost. Regulation 109 is the converse of regulation 108, i.e. the change of intention is from exempt or dual supplies to taxable supplies and a claim for the VAT not originally recovered can be made.
The case of The Royal & Sun Alliance Regulation 109 was the point in the case of Royal & Sun Alliance Insurance Group plc (RSA) (2003) STC 832. RSA had five vacant properties (which it had previously occupied) on which it had not opted but was paying VAT on the rent. The properties were vacant for some years during which time RSA tried to let them. RSA eventually opted on the properties and sought to recover VAT incurred under Regulation 109.
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The case went from the VAT tribunal to the House of Lords who found for Customs. The House of Lords decided that, based on the time of supply rules for leases, there were separate supplies with each payment. The earlier supplies had been used up while the properties were vacant and had not been used by RSA to make taxable supplies. The House of Lords did not accept that RSA did not have a firm intention to make either taxable or exempt supplies and a definite intention was required in order to use Regulation 109. In passing it was suggested by the House of Lords that RSA had been entitled to treat the VAT as non-attributable under the normal partial exemption method. This was of little use to RSA who were heavily partly exempt. However, it appears from the judgement that a fully taxable business would have been allowed full recovery, but Customs has not made its views known.
Abortive and speculative developments Whether and to what extent VAT can be recovered where a project has been aborted or the project is purely speculative has been the subject of some debate and confusion. Customs issued an Information Sheet 8/01 which sets out their general policy after previously taking an inconsistent approach. The Information Sheet suggests that provided the intended use was taxable, VAT recovered need not be adjusted when a project is aborted unless the costs are applied to a different project (with an exempt or partly exempt liability).
Recovery of VAT prior to an option to tax Customs originally held the view that VAT could not be recovered before a valid option had been notified. This view appeared to be wrong and the position was clarified in the case of Beaverbank Properties Ltd (VTD 18099).
The case of Beaverbank Properties Ltd Beaverbank were involved in what became an abortive property transaction. The company had incurred VAT on fees for a failed attempt to obtain planning permission. Customs denied the claim for VAT recovery on the grounds that in the absence of an option the intended supplies could only have been exempt. The tribunal supported Beaverbank. The tribunal accepted that company
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policy was to opt following planning permission. It also noted that without an option the project would have been far less profitable. Customs accept, following the decision in Beaverbank Properties, that a business which can demonstrate a clear intention to opt can recover VAT on related costs. It is unlikely they will accept a clear intention where prior permission was required. In practice if a business does have a clear intention to opt and is incurring VAT the business may as well notify the option. However, the Beaverbank decision affords a measure of flexibility.
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Chapter 7 Capital goods scheme Why have a Capital Goods Scheme? ................................................55 Application of the scheme ..................................................................55 Additions to the scheme .....................................................................56 Definition of a capital item..................................................................56 Where CGS does not apply ................................................................57 Initial VAT recovery.............................................................................57 Value .....................................................................................................58 Intervals ................................................................................................59 Example ................................................................................................60 CGS effect on other disposals ............................................................61 Record keeping ....................................................................................62
Chapter 7 Capital goods scheme
Why have a Capital Goods Scheme? The recoverability of VAT on the cost of acquiring assets is normally determined on a one-off basis by reference to the use to which the asset is initially put. If the initial use is taxable the VAT is recoverable. The VAT is irrecoverable if the initial use is exempt. However, where long-term assets are concerned the use may well change over the years. The Capital Goods Scheme (CGS) provides a mechanism for adjusting input tax over a period of years to reflect any changes of use.
Application of the scheme The UK introduced the CGS in 1990 and the scheme currently applies to certain properties and related works and to items of computer equipment. As far as property is concerned, the CGS provides for adjustments to the original VAT incurred on the purchase to be made over a period of ten intervals (normally equating to ten years). The scheme was introduced on 1 April 1990 and applies to: •
freehold land and buildings supplied to the business by way of a standard rated supply where the value is not less than £250,000;
•
leasehold land and buildings supplied subject to a standard rated premium of not less than £250,000;
•
building subject to self-supply provisions of Para 1(5) Schedule 10 the VAT Act 1994 (which is a change of use charge applicable to RRP and RCP buildings) where the value of the supply is not less than £250,000;
•
building constructed by the business which do not fall within the self supply charge referred to above where the standard rated building costs incurred are not less £250,000; and
•
buildings which the business alters or extends, thereby increasing the floor area by 10% or more, where the value of standard rated goods and services supplied to the business were not less than £250,000.
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Additions to the scheme Additions to the scheme were introduced in 1997. From 3 July 1997 the scheme applies to: •
civil engineering works constructed by the owner and first brought into use on or after 3 July 1997, where the taxable value of land and the value of all standard rated taxable supplies made to the business on or after 3 July, is not less than £250,000; and
•
a building which the owner refurbishes or fits out where the value of standard rated taxable supplies made to him on or after 3 July 1997 is not less than £250,000.
It should be noted that the value of £250,000 is exclusive of VAT. The scheme value limit has not changed since the scheme was introduced in 1990 and, therefore, an increasing number of buildings and construction works are falling within the CGS. Although often, and quite rightly, the CGS is considered in conjunction with partial exemption rules, the scheme can impact on fully taxable businesses which dispose of properties used in the business.
Definition of a capital item For an asset to be within the CGS: •
it must be treated as a capital item; and
•
the VAT must have been incurred in one of the specified sets of circumstances referred to above.
For the purposes of the CGS, a capital item is defined in Regulation 112(2) of the VAT Regulations 1994 as ‘an item which a person (hereinafter referred to as the owner) uses in the course or furtherance of a business carried on by him and for the purpose of that business, otherwise then solely for the purpose of selling that item’. It can be seen from the above definition that the scheme does not apply to buildings held solely for sale, and to use for non-business activities.
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Accounting treatment important Customs will generally accept the owner’s normal accounting treatment in determining what capital expenditure is. Customs say that expenditure is likely to be of a capital nature if the work is of lasting benefit and increases the value of the property. The legislation does not define refurbishment or fitting out. The presumption is that any building work costing £250,000 or more should be included if it is capitalised in the accounts and does not fall under one of the other Capital Goods Scheme headings. In the case of refurbishment or fitting out, the purchase price of the land and any rent are excluded from the calculation as are any supplies made before 3 July 1997.
Where CGS does not apply The CGS does not apply to the acquisition of land and buildings of a value of less than £250,000, the acquisitions of leases, land and buildings where the premium is less than £250,000 or where no premium is paid, and freehold bare land purchased for possible future development and not used before development or sale. The CGS does not apply to refurbishments and extension costing less £250,000, or extensions costing £250,000 or more and where the increase in floor area is less than 10%.
Initial VAT recovery Initially, VAT on the cost of acquiring or constructing the capital item is recoverable in accordance with the normal rules for deduction of VAT. If the item is to be used wholly for the purposes of making taxable supplies the VAT incurred will be recoverable in full. If the item is to be used wholly for the purpose of making exempt supplies then the VAT incurred will be wholly irrecoverable. If the item is to be used partly for taxable purposes and partly for exempt purposes, the recoverability of the VAT incurred will be determined by reference to the business’s agreed partial exemption method for the period in which the item is acquired, subject to the annual adjustment.
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Value As stated above, the acquisition of property or expenditure on construction/refurbishment works is only within the CGS if the owner incurs VAT on supplies to a value of £250,000, excluding VAT.
Property acquisition On acquisition of a property the value for the purpose of the CGS includes the purchase price of a property or the lease premium. Rents, and charges reserved as rent, are ignored unless they are paid or payable within 12 months in advance, or invoiced for a period of more than 12 months. This can be illustrated by an example: •
Lease purchased for a premium of £230,000 plus VAT.
•
Rent is £2,000 per month.
•
Property is not within the CGS as value (ex VAT) is less than £250,000. However, if the first years rent had been payable in advance the value would have been exceeded.
Fees associated with the acquisition are also ignored.
Construction The value where a building is constructed includes the purchase price, including a lease premium or rent, of the land, and all the construction related costs if they are subject to VAT. Customs provide guidance in their Notice 706/2 on the construction related costs to be included in the Capital Goods Scheme for: •
construction of a building;
•
the enlargement of a building;
•
the refurbishment or fitting out of a building; and
•
the construction of a civil engineering work.
Customs state that you should include all the costs involved in making a building ready for occupation such as: •
professional and managerial services including architects, surveyors and site management;
•
demolition and site clearance;
•
building and civil engineering contractors’ services;
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•
materials used in the construction;
•
security;
•
equipment hire;
•
haulage;
•
landscaping; and
•
fitting out, including the value of any fixtures.
Refurbishment Where a building is refurbished the calculation of the value only includes capital expenditure and related services, and goods affixed to the building in connection with the works.
Phased refurbishment It can be unclear whether a phased refurbishment should be treated as a single refurbishment, or as a series of separate refurbishments of different parts of the building. This can of course be extremely relevant to the £250,000 limit. If the work is only phased because the building is occupied throughout and is under a single contract, Customs will normally regard this as a single refurbishment. However they would accept separate refurbishments where there are time intervals between the phases and the work is separately contracted for.
Intervals Normally, the CGS adjustment period commences on the day on which the asset is acquired. The period from that date to the day before the following tax year is known as the ‘first interval’. Adjustments are made over the following nine intervals and therefore intervals other than the first interval consist of twelve months. However, intervals can be less than twelve months, e.g. where property is sold or otherwise disposed of.
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The method of adjustment If the extent to which the property is used in making taxable supplies changes during the adjustment period, an adjustment has to be made. This is calculated as follows: total input tax on capital item
x adjustment percentage
number of intervals in adjustment period The adjustment percentage is the difference, if any, between the extent to which the item is used in making taxable supplies in the first interval and the extent in which it is used in the subsequent interval. If taxable use is increased, an additional amount of VAT is recoverable from Customs, whereas if taxable use is decreased a further amount of VAT will be payable to Customs. The adjustment is made in the second period of the businesses’ VAT year (a VAT year ends on 31 March, 30 April or 31 May depending on the businesses’ VAT return periods). Thus, if a business preparing quarterly returns has a VAT year to 31 March 2003, any capital goods scheme adjustments for the year will be made in the VAT period to 30 September 2003.
Example Strictly Limited is a partly exempt company with a VAT year to 31 March. It purchases a property on 1 September 2003 for £300,000 plus VAT of £52,500. In the period to 31 March 2004 (interval 1) it is regarded as using the property as to 60% in making taxable supplies. In the VAT year to 31 March 2005 (interval 2) the taxable use drops to 50%. The VAT recovered in interval 1 is £31,500 (60% of £52,500). As the taxable usage decreases in the second interval an adjustment is required. This is calculated as follows: 52,500 x (50%-60%) 10 i.e. £5250 x -10% = £525. Accordingly, a further £525 will become payable to Customs.
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Businesses making only taxable supplies Businesses which only make taxable supplies will be able to recover VAT in full on costs of purchasing a property, constructing an extension or refurbishing a property for use in the business. Such businesses frequently believe that they have no need to concern themselves with the CGS. Unfortunately, there is a VAT trap which a business can fall foul of if a CGS property is sold during the adjustment period.
Example The trap springs because of the liability of the sale of a property. If a property is sold without opting to tax, the sale is exempt. The CGS rules provide that where a property is sold and the sale is exempt, the property is deemed to be used for making exempt supplies for the remaining CGS adjustment periods. The trap can be illustrated by an example: Blundell Limited produces fish fingers. It purchases a factory on which it is charged VAT of £500,000. As the sale of fish fingers is taxable (albeit at the zero rate), Blundell Limited can recover the VAT charged on the purchase. Five years later Blundell receives a good offer for the property. It sells the property and because it has not opted to tax, the sale is exempt. Consequently, the property is deemed to have been used for five years for exempt purposes resulting in half the input tax (£250,000) being repayable to Customs. Blundell Limited could have avoided the VAT clawback charge by opting to tax the property or at least negotiated the price to include the clawback (if the purchaser did not want to pay VAT).
CGS effect on other disposals Disposal as a transfer of a going concern (TOGC) Where a building is transferred as a TOGC, the current interval under the Capital Goods Scheme comes to an end. The transferee is expected to take over the transferor’s obligations to make adjustments. In order to do this, the transferee needs to be provided with details of the VAT originally incurred and recovered on the asset, and of adjustments in subsequent intervals (see Chapter 7).
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Loss or destruction If a property is totally destroyed there is no further adjustment for subsequent intervals. Destruction obviously includes total demolition, if the demolition occurs within the CGS period. There are cases where refurbishment works are destroyed within 10 years and Customs say that if this happens, this should be treated as destruction if no elements of the earlier refurbishment work remain, and the earlier work is stripped out and replaced. Customs expect adjustments to continue if elements of the earlier refurbishment are retained when carrying out the work.
Expiry of short lease If the property is held on a lease which expires during the Capital Goods Scheme period, there is no further adjustment for subsequent intervals.
De-registration There are specific rules where a business de-registers while it has an asset on hand which is within the CGS. In most cases there will be a deemed supply of the asset on registration. This deemed supply is then treated under the CGS in the same way as an actual disposal. A business which de-registers is issued with a final VAT return and this should include the final adjustment.
Record keeping Businesses are required to maintain records which enable them to calculate the CGS adjustments on each item for the current and the future intervals. For each item within the CGS, Customs expect business records to show how adjustments have been calculated and include: •
a description of the item;
•
its value;
•
the amount of VAT incurred;
•
the amount of VAT recovered;
•
the start and end date for each interval; and
•
the date and value of any disposal during the adjustment period.
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Customs expect the CGS records or copies of them to be transferred to the purchaser on a TOGC, even if the transferor has their permission to retain the originals. Depending on the number of intervals remaining, records have to be retained for up to 16 years.
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Chapter 8 Transfers of going concerns Introduction..........................................................................................65 The UK legislation ...............................................................................65 Consequences of TOGC treatment ....................................................66 Seeking Customs confirmation ..........................................................67 European dimension ..........................................................................68 Interaction between the TOGC and property rules.........................69 Relevant date........................................................................................70 Customs’ views ...................................................................................71 TOGC benefits......................................................................................71 A capital goods scheme issue.............................................................72 Recovery of VAT on costs of TOGC transactions ............................72
Chapter 8 Transfers of going concerns
Introduction The sale of a new non-residential property or a property on which the option to tax has been exercised, is subject to VAT at the standard rate. However, any person dealing in property has to be aware of the transfer of going concern (TOGC) regulations. In this chapter the rules are explained and considered in detail, with particular emphasis on property transactions. The TOGC regime is often referred to by Customs as being a VAT relief. Although certainly the rules relieve the purchaser of a business from paying VAT, the regulations were in fact one of the first anti-avoidance measures. Soon after VAT was introduced in 1973, Customs became concerned that VAT was being leaked from sales of businesses. Vendors were charging VAT and the purchasers were entitled to recover the VAT charge. However, it was sometimes difficult for Customs to extract VAT from certain unscrupulous vendors who, having sold their businesses, disappeared.
The UK legislation When a building is sold, the VAT liability will depend upon the nature and type of the building concerned. If the building is a new commercial building on which an option to tax has been made in respect of the property, the disposal will be standard rated. If not, the disposable will be exempt. However, if the property is sold as, or part of, the transfer of a business as a going concern, then the supply of the building will be outside the scope of VAT. The relevant legislation is Article 5 of the Value Added Tax (Special Provisions) Order 1995 (SI 1268). The VAT legislation provides that the supply by a person of the assets of his business to another person to whom he transfers his business as a going concern
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is, subject to various conditions, neither a supply of goods nor a supply of services. Article 5 provides as follows: ‘5-(1) subject to paragraph (2) below, there shall be treated as neither a supply of goods nor a supply of services the following supplies by a person of assets of his business: a)
The supply to a person to whom he transfers his business as going concern where: i)
The assets are to be used by the transferee in carrying on the same kind of business, whether or not as part of any existing business, as that carried on by the transferor, and
ii)
In a case where the transferor is a taxable person, the transferee is already, or immediately becomes as a result of the transfer a taxable person or a person defined as such in Section 2(2) of the Manx Act.
b)
The supply to a person to whom transfers part of his business as a going concern where: i)
That part is capable of separate operation,
ii)
The assets are to be used by the transferee in carrying on the same kind of business whether or not as part of an existing business as that carried on by the transferor in relation to that part, and
iii)
In the case where the transferor is a taxable person, the transferee is already, or immediately becomes as a result of the transfer, a taxable person or a person defined as such in Section 2(2) of the Manx Act.’
Consequences of TOGC treatment The TOGC regulations were introduced to disapply the VAT charges on the sales of businesses. The danger is that if a vendor charges VAT on a transfer of a business when he should not have done, Customs can refuse the purchaser’s claim for VAT recovery. In contrast, if a vendor does not charge VAT when he should have done, Customs can assess for the VAT payable. Since the introduction of penalties and interest in the late 1980’s, sale and purchase agreements normally contain numerous VAT clauses and warranties. The TOGC rules are mandatory where all the conditions apply. The main difficulty when applying the rules is that it is impossible for the vendor to determine the VAT position in isolation as the TOGC treatment is dependent on the purchaser’s status and intentions.
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Seeking Customs confirmation The standard clauses in sale agreements usually include a requirement for the transferor to seek Customs’ confirmation of the TOGC position. Unfortunately, Customs will often decline to give confirmation in a case which they consider straightforward. Alternatively, Customs will respond by simply referring to the public notice rather than give any ruling on the specific circumstances. Another factor to bear in mind is that Customs mainly refuse to give rulings or decisions to a purchaser. This can be a problem when the purchaser disputes the position taken by the vendor as if the vendor is charging VAT on a sale, the purchaser is exposed, i.e. input tax recovery is at risk.
The case of the Gardner Partnership The TOGC regulations interact with property VAT law in a way which causes untold problems for businesses. There have been numerous cases before the tribunals and courts. An example is the case of the Gardner Partnership (LON/90/958) the appellant partnership was formed to develop a site as a business estate. The partnership intended to make taxable supplies and reclaimed VAT on costs with respect to planning and professional fees. It carried out road widening, installation of drainage and construction of electricity and gas stations. It sold the entire property together with a building it had used as an administrative office to another developer having received an unexpected offer. Customs sought to recover the input tax which had been reclaimed because an exempt supply had been made (the option to tax had not been exercised). The partnership contended that the land and the administrative offices were sold as a going concern. The VAT tribunal decided that at the time of the sale the land was in the course of active development, the purchaser had continued the development without a break, completing the building work commenced by the partnership and granting zero-rated leases of new buildings. The tribunal concluded that there was a transfer of a business as a going concern.
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European dimension Customs seem to take both a broad and narrow view of the TOGC regulations depending on how it suits them. It will be interesting to see how they will react to the decision of the ECJ in the case of a Luxemburg company, Zita Modes Sarl (CJEC Case C-497/01). The case appears to cast doubts not only on some of the UK case law but on some of the UK provisions.
The case of Zita Modes Sarl Zita Modes Sarl sold a clothing business to Milady, which operated a perfumery business. Milady was not authorised to carry on a clothing business in Luxemburg and the authorities contended that the sale had not been a TOGC. The ECJ disagreed and made some observations about Article 5.8 of the Directive, which is the basis for TOGC treatment in the UK and elsewhere. Article 5.8 stipulates: ‘In the event of a transfer, whether for consideration or not or as a contribution to a company, of a totality of assets or part thereof, Member States may consider that no supply of goods has taken place and in that event the recipients shall be treated as the successor to the transferor. Where appropriate, Member States may take the necessary measures to prevent distortion of competition in cases where the recipient is not wholly liable to tax.’ The Court said broadly that the condition of TOGC treatment that the assets are used by the transferee for the same kind of business as the transferor is not an express requirement of Article 5(8) of the Sixth Directive. At the time of writing, Customs have yet to make any public comment on this case. The decision does have implications in the UK and the consequence appears to be that restrictions can only be introduced to TOGC treatment to deal with cases where the transferee is not fully taxable. It could be that the UK’s approach to TOGCs and the interaction between the TOGC rules and the option to tax regulations is invalid.
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Interaction between the TOGC and property rules Where the transfer of business assets includes commercial property there are two further conditions. These conditions apply where a vendor has opted to tax the land, or building, or new or incomplete buildings or works are transferred (these are normally mandatory standard rated).
Need for purchaser to opt The first condition is that unless the transferor has exercised the option to tax in respect of the land and buildings, and notified his or her option in writing to Customs no later than the relevant date (see below), the transfer of going concern treatment is not available for the sale. As a consequence the vendor will have to charge and account for VAT on the transfer of the property.
Notification by purchaser – non-disapplication The second condition is an anti-avoidance measure and was introduced without prior notice on 18 March 2004. The transferee must notify the transferor that his or her (the transferee’s) option will not be dis-applied under the anti-avoidance rules (see Chapter 9). Disapplication broadly means that the transferees will not be letting the property concerned to any exempt or partly exempt occupiers who, are either connected to them; provided funding for the acquisition; or are connected to persons who provided funding. In the vast majority of transactions the purchasers will be able to provide the required notification. The notification can be in any form, e.g. a side letter, specific clause in the agreement or by a warranty clause. If purchasers do not provide the notification VAT will be chargeable by the vendor regardless of whether there is any avoidance motive, i.e. even in the most straightforward of transactions. Customs received some criticism for the way the additional condition was introduced and agreed to apply a ‘light touch’ for a few months following the change. This period has now expired but it remains to be seen whether the need for notifications is in breach of European law following the Zita Modes Sarl case, described earlier in this chapter.
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Relevant date It should be noted that the option by the purchaser must actually be notified to Customs & Excise, not simply made before the relevant date if going concern treatment is to apply. The relevant date is the earliest date in which a supply in connection with the transfer of the building is made. The earliest date is normally the earlier of the date of completion or payment (if a deposit is paid to the vendor’s agent, but not to anyone acting as stakeholder). This condition caused problems and a concern following the decision in the case of Higher Education Statistic Agency Limited (HESA) (QB (2000) STC 332).
The case of the Higher Education Statistics Agency HESA purchased a building at auction and paid a deposit to the auctioneer. Subsequently, HESA notified Customs of its option to tax. However, Customs’ view, which was supported by the VAT tribunal and upheld by the High Court, was that HESA had not notified its option on or before the relevant date, ie in this case the payment of the deposit to the auctioneer as agent of the vendor. This meant that the transaction could not be treated as a transfer of going concern, and the vendor had to charge and account for VAT at the standard rate. It was thought that the only safe remedy for purchasers other than opting on all properties in the catalogue of the auction was to fax the option to Customs on the day of the sale. However, the case of Chalegrove Properties Ltd (VTD 17151) indicates that it is sufficient for the option to be posted to Customs on the day, i.e. the option does not have to be received by Customs on the same day as the auction. This problem does not arise where the auctioneer is acting as stakeholder. Payment of a deposit to a person acting as stakeholder does not constitute a tax point and therefore is not a relevant date.
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Customs’ views Customs’ views on whether or not a transaction is capable of TOGC treatment are contained in Notice 700/9. Assuming that the conditions concerning registration and notification of the option to tax are met the following is a summary of Customs’ views: •
Sales with the benefit of existing leases can be a TOGC, even if the property is only partly tenanted.
•
The sale is during a rent free period.
•
Tenants are not yet in occupation.
•
The lease has not been signed, provided a tenant has been found and the sale is with the benefit of the respective tenancy.
•
A developer’s sale of a site consisting of let and unlet, finished or unfinished properties can be a TOGC if it is to a single buyer.
There is no TOGC: •
if the tenant cannot remain after the sale;
•
the owner is still looking for a tenant;
•
the transaction is a grant of a lease;
•
the current tenant’s lease is surrendered immediately before the sale even if sub-tenants remain; or
•
the sale is to the sole tenant.
TOGC benefits If a transaction is treated as a TOGC, the transaction is not a supply and therefore no VAT is chargeable. There are beneficial VAT cash flow considerations for the transferee who will not have to fund the VAT payment in advance of recovering the VAT from Customs which may be up to four months later. There is a stamp duty land tax saving. This is because if a sale is subject to VAT, stamp duty land tax is payable on the whole consideration including the VAT element. Obviously, where no VAT is chargeable on a sale, the stamp duty land tax will be correspondingly less.
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A capital goods scheme issue One of the consequences of a TOGC is that if the building is within the Capital Goods Scheme (see Chapter 7) the transferee has an obligation to take on the transferor’s Capital Goods Scheme adjustments. The adjustments are based on the original input tax recovery by the transferor. The transferor will have to provide the transferee with sufficient information to enable the transferee to make the adjustments.
Recovery of VAT on costs of TOGC transactions There have been problems with the recovery of VAT on professional fees etc bearing in mind that a TOGC is not a supply for VAT purposes. Customs attempted to deny recovery of VAT to transferors.
The case of Abbey National The issue came before the Courts in the case of Abbey National plc (ECJ Case C408/98, (2001) STC 297). The case was referred to the ECJ by the domestic Courts. The ECJ held that provided the lettings from a property were ‘a clearly defined part’ of its activities then the VAT on costs could be recovered if the property lettings were taxable, i.e. opted property. Following the decision of the ECJ, Customs accept that VAT related to a disposal of property can be treated as an overhead of the business (or part of the business) that is transferred. If the business or part makes only taxable supplies the VAT is recoverable in full; if it makes only exempt supplies, none of the VAT can be recovered. A business or part making both taxable and exempt supplies can recover VAT in accordance with its partial exemption method.
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Chapter 9 VAT avoidance Introduction..........................................................................................74 Option for VAT planning ....................................................................74 Customs efforts to combat avoidance...............................................75 Anti-avoidance legislation ..................................................................75 Disclosure rules....................................................................................78
Chapter 9 VAT avoidance
Introduction Expenditure on property represents one of the three largest costs for most businesses. With the introduction of VAT on commercial property in 1989, property became the largest VAT cost that a business would have to handle. It is not surprising therefore, that businesses which could not recover all the VAT it incurred sought to mitigate the VAT cost as far as possible.
Option for VAT planning The option to tax facility became the most used VAT planning tool. On the introduction of the option to tax in 1989, there were no anti-avoidance rules. It was perfectly possible for an exempt or partially exempt business to enter into a lease and lease back agreement with an associated company in order to spread the VAT cost. This simple arrangement can be illustrated by the following example: Jacob Ltd is an exempt business. It wishes to acquire a property. It purchases the property in its subsidiary; Alex Ltd. Alex Ltd opts to tax, recovers VAT on the acquisition of the property and charges a rent plus VAT to Jacob Ltd. Although there will be a VAT cost on the rents, it was possible to minimise the cost and, depending on the complexity of the scheme adopted, create an absolute saving as well as a cash flow saving. One of the first property planning schemes to come before the Courts was undertaken by Robert Gordon’s College (HL (1995) STC 1093). The scheme was challenged by Customs but successfully defended by the College in the House of Lords.
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Customs efforts to combat avoidance Customs made an effort to tackle what they perceived as unacceptable abuse of the option to tax system in 1994. Their first effort, ie to dis-apply any option made by connected parties, failed and was withdrawn. The current anti-avoidance rules were introduced in 1997 and extended in 1999 to combat a particular planning scheme.
Anti-avoidance legislation The anti-avoidance legislation is extremely complex and there are many traps for the unwary. There are numerous cases where, if followed strictly, the rules dis-apply an option to tax where there is no avoidance intended by the parties involved. In the author’s experience, Customs have been helpful where it can be demonstrated to them that no avoidance was intended. However, Customs’ helpfulness cannot be relied upon. The VAT legislation works to dis-apply an option to tax, ie the option is ineffective, if three tests are met at the time of the grant. The rules were introduced on 19 March 1997. The tests are as follows: 1
The property must be within or intended to be within the Capital Goods Scheme (CGS) adjustment period in the hands of the grantor or of a person to whom the property is to be transferred.
2
The grantor, or someone financing the grantor, must intend or expect that the property will be occupied by:
3
•
the grantor or financier; or
•
someone connected with one or other of the above.
The grantor, or person financing the grantor, must intend or expect the occupier will use the property for an activity which does not consist wholly or mainly in making taxable supplies. In this context, wholly or mainly according to Customs means 80%, but this has not been tested.
Capital Goods Scheme (CGS) The CGS is explained in Chapter 7. Broadly, the CGS applies where a property is acquired for a sum in excess of £250,000 or works were carried out to the property at a cost of more than £250,000 and VAT is payable on the acquisition
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or cost of the works. The CGS adjustment period is normally between 9 and 10 years and the anti-avoidance rules do not apply outside of the CGS adjustment period.
Occupation Occupation need not be exclusive and if any of the occupiers are within the test the option is potentially disapplied. Occupation was in point in the case of Brambletye School Trust Ltd (VTD 17688). The Trust ran a school and constructed a sports hall which it leased to a subsidiary. The subsidiary company ran a sports club which included school pupils as members. Pupils using the hall were supervised by school staff. The Trust opted to tax. However, the VAT tribunal decided that its option was disapplied. The tribunal rejected the Trust’s argument that only the subsidiary company was in occupation of the hall. The presence of school staff meant that the school was at least in joint occupation. It is only the intention or expectation at the time of the grant that is relevant. It is incumbent upon the business though to demonstrate to Customs that subsequent events (resulting in the non-taxable use of the property) were not contemplated at the time of the grant.
Financing The definition of financing is very wide. Financing an acquisition or development means: •
providing finance for it by directly or indirectly providing funds for meeting the whole or any part of the cost, including loans and guarantees; or
•
procuring the provision of funds by a third party or providing funds for discharging any or all of the liability that has been or may be incurred by any person in connection with the raising of funds to meet the cost of the development.
The case of Winterthur Life As an example of how wide ranging funding is, lessons can be learned from the case of Winterthur Life UK Limited (VTD 15785). In this case the occupiers of a property (a partnership) carried on an exempt insurance business. The pension fund acquired the property, opted to tax and let the property to the
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partnership. Customs took the view that the pension fund’s option could not apply as the partnership, by paying contributions, had provided funds. Customs’ view was supported by the VAT tribunal.
The case of Halifax & Others The case of Halifax plc & Others (2001) VTR73 (17124) demonstrates the extent and focus of Customs’ legal arguments to defeat VAT avoidance. The case is currently with the ECJ. At the time of writing, the ECJ has still not given its decision. It is likely that however the ECJ decide to answer the questions raised, the case will be referred back to the UK courts to decide the outcome. It is worth considering Halifax in some detail. Halifax wished to construct new call centres by entering into a construction contract with a third party. As Halifax is heavily partially exempt, the VAT incurred would be a real cost to Halifax. Halifax novated the construction contract to a subsidiary company, CWPI, and transferred its land interests to another subsidiary, LPDS. Both companies were outside the Halifax VAT group. LPDS entered into a construction contract with CWPI and pre-paid the contract value in one VAT year. In that same VAT year it also invoiced a staged payment for work done for Halifax, thus making taxable supplies in the VAT year in question. As LPDS had only made taxable supplies it was able to fully recover the VAT incurred in that particular VAT year. In the subsequent VAT year LPDS transferred its property interest to HPIL, another Halifax subsidiary, for a premium which included the cost of the works. This premium was an exempt supply. However, under the partial exemption rules there was no requirement for LPDS to repay the earlier VAT recovery because it was not a capital item in the hands of LPDS. HPIL then leased the properties to Halifax (without the need to opt to tax which would have been dis-applied). Halifax therefore saved in the region of £7 million VAT. Customs had two principal arguments: •
A transaction entered into solely for the purposes of VAT avoidance was neither itself a supply nor a step taken in the course of furtherance of Halifax’s economic activity, in the context of the Sixth Directive and equivalent terms in the VAT Act 1994.
•
Transactions entered into solely for the purpose of VAT avoidance should, in accordance with the general principles of EC law preventing ‘abusive rights’ be disregarded and, instead, the terms of the Sixth Directive are applied to the true nature of the transactions in issue.
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The VAT tribunal found in favour of Customs. The consequence was that the tribunal stated that the true reality of the transaction was that the supply was made by the contracting company to Halifax and the intervening transactions should be ignored. The case was appealed to the Higher Courts who referred the matter to the ECJ. The Advocate General of the ECJ had not yet given his opinion at the time of writing.
Disclosure rules The anti-avoidance legislation introduced in 1997 has all but killed off avoidance schemes using the option to tax facility. Buyers have had to devise other methods. Customs are attacking avoidance schemes vigorously and have introduced new disclosure rules. The rules relevant to property transactions are described below. Customs introduced rules last year to compel businesses to disclose use of certain VAT avoidance schemes. There is a published list of schemes. Any business with a turnover in excess of £600,000 which is using one or more of the listed schemes has to make a disclosure to Customs. The schemes involving commercial property are sale and leaseback schemes. In addition there are ‘hallmark schemes’. Customs has published what they consider are hallmarks of avoidance. Hallmarks include construction supplies between connected parties. Disclosure has to be made by businesses with a turnover in excess of £10 million. Full details are contained in Customs notice 700/8. Businesses need to read the notice carefully as the descriptions appear to be widely drawn and require businesses to notify many normal commercial transactions. There are penalties for failure to disclose.
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Chapter 10 Conversions to dwellings and RRP buildings Introduction..........................................................................................80 Examples of conversion from non-residential .................................80 Disapplication of the option to tax ....................................................81 Relevant residential purpose ..............................................................82
Chapter 10 Conversions to dwellings and RRP buildings
Introduction The VAT rules relating to residential property are outside the scope of this report. The sale, leasing and letting of ‘old’ residential property is exempt from VAT. This means that the constructor/developer cannot recover VAT on related costs. However, the freehold sale or grant of a long lease in new dwellings has always been zero-rated, allowing developers to recover VAT on related costs. In 1994 zero-rating was extended to cover the first grant of a major interest in any part of a building, dwelling or its site by a person converting: •
a non-residential building; or
•
a non-residential part of a building
into a building designed as a dwelling or a number of dwellings, or building intended for use solely for a relevant residential purpose.
Examples of conversion from non-residential Examples of a non-residential conversion include the conversion of: •
a commercial building (such as an office, warehouse, shop, etc);
•
an agricultural building such as a barn; or
•
a redundant school or church.
into a building designed as a dwelling or number of dwellings, or a relevant residential building.
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Dwelling A dwelling must consist of self-contained living accommodation for a conversion from non-residential to qualify for zero rating. The rules cover buildings for use as a number of dwellings, e.g. a block of flats. A further condition is that residence must not be restricted or prevented (see Chapter 2, Holiday accommodation). If living accommodation is not sufficiently self contained to qualify as a dwelling it may still qualify as being used for relevant residential purposes. Where part of a building is already in use as a dwelling then, for the grant of a major interest to qualify for zero rating, the conversion must create an additional dwelling. There have been a number of issues relating to public house conversions where zero rating has been denied because the landlord of the public house uses part of the property as living accommodation.
Disapplication of the option to tax Where a non-residential property on which the owner has opted to tax (see Chapter 4) is sold to a person who intends to convert the property to a dwelling or a relevant residential building, the option is disapplied. This means that the option is ineffective and, rather than being taxable, the sale will be exempt. Disapplication can cause problems and be expensive for vendors as there may be a clawback of VAT originally claimed, and VAT on selling costs etc may be irrecoverable. It is possible to retain the option if both vendor and purchaser agree in writing to do so. The agreement is only effective if the person acquiring the property intends to make zero rated supplies following conversion, i.e. sale of freehold or grant of lease of over 21 years. Where a purchaser intends to grant short leases the vendor’s option will be disapplied. It should be stressed that agreement of the purchaser must be obtained. The purchaser will have to compare the cost of incurring ‘hidden’ VAT, i.e. the vendors irrecoverable VAT, in the price payable against the increased stamp duty land tax which will become payable on the VAT element of the consideration.
The case of SEH Holdings Ltd In the case of SEH Holdings Ltd (VTD 16771) (TVC 6.2), a brewery sold a disused public house on which it had opted. SEH Holdings Ltd (SEH) purchased and sold the property on the same day to a charity that were going to award SEH
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a contract to convert the pub to dwellings. The argument before the tribunal was that the brewery’s option should be disapplied. The tribunal found otherwise. The decision prompted Customs to issue Business Brief 8/01 confirming that, with effect from 1 August 2001, a vendor who has opted must account for VAT on the sale if the immediate purchaser does not intend to either use the property as a dwelling or convert it himself. Customs admitted that their previous published guidance was unclear. The author admits bias having presented the case to the tribunal but still feels the case was wrongly decided. The legislation, i.e. VAT Act 1994, Sch 10, item 2 (2) (a), clearly states that an election shall not apply ‘if the grant is made in relation to a building or part of a building intended for use as a dwelling or number of dwellings…’ There is no indication that ‘for use’ has to be by the immediate purchaser.
Relevant residential purpose Note (4) to Schedule 8, Group 5 of VAT Act 1994 defines use for a relevant residential purpose as: a)
a home or other institution providing residential accommodation for children;
b)
a home or other institution providing residential accommodation with personal care for persons in need of personal care by reason of old age, disablement, past or present dependence on alcohol or drugs or past or present mental disorder;
c)
a hospice;
d)
residential accommodation for students or school pupils;
e)
residential accommodation for members of any of the armed forces;
f)
a monastery, nunnery or similar establishment; or
g)
an institution which is the sole or main residence of at least 90% of its residents, except use as a hospital, prison or similar institution or a hotel, inn or similar establishment.
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1 0 CONVERSIONS TO DWELLINGS AND RRP BUILDINGS
Conditions for zero rating an RRP building Zero rating for the grant of a major interest in a RRP building is not available unless before the grant is made, the grantee gives the grantor a certificate of use. The certificate prescribed by Customs and which has the force of law is contained in notice 708. However, grantees can create their own certificates provided the certificates contain the same information. There is a penalty equal to the VAT that should have been charged for the issue of incorrect certificates. Customs will not penalise the grantor provided the grantor had taken reasonable steps to ensure that the grantee was eligible to issue the certificate.
Change of use of an RRP building Rules were introduced to counter any change of use of a relevant residential building. If there is a change of use within a ten-year period following completion of the building the person who issued the certificate has to account for VAT as if he had made a standard rated supply to himself. The formula for the self supply charge is VAT which would have been charged multiplied by (ten less the number of years of use as a RRP building) and divided by ten. If the building is disposed of either by sale or lease within the ten year period and the building or part will no longer be used for a relevant residential purpose, the otherwise exempt disposal is standard rated. In a part disposal an apportionment can be made.
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Chapter 11 Option to tax – past, present and future Introduction..........................................................................................85 The past.................................................................................................85 The present...........................................................................................87 The future .............................................................................................87
Chapter 11 Option to tax – past, present and future
Introduction The option to tax regime has been in place for nearly 15 years at the time of writing. The options to tax rules have been subject to various changes since those ‘innocent’ days of the early 90s. Many of the changes have been driven by Customs desire to ‘stamp out’ both actual and perceived avoidance. Other changes have been as a result of case law and the European influence on UK domestic legislation.
The past When the option to tax was introduced there were fears that the regime would create a ‘two-tier’ market. These fears have been largely unfounded. It has not been uncommon for tenants who are exempt or partly exempt to purchase buildings on which the landlord has opted to tax. It is fair to say that many businesses (and Customs) were ignorant about the long-term effects of opting on a building, particularly in the early days of the option regime and this ignorance has led to various problems and issues surfacing in recent years. Many businesses simply opted on all their properties with a few making ‘blanket’ options covering not only properties in the business’s current portfolio but on future acquisitions. Customs no longer accept blanket options. Other businesses opted on properties simply because they thought they had to, whereas others charged VAT on rents without notifying Customs of an option, mainly through ignorance of the complex rules in place. Many of these problems were resolved by the Courts, some of them to the taxpayer’s advantage, but sometimes the errors proved expensive.
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1 1 O P T I O N T O TA X – PA S T, P R E S E N T A N D F U T U R E
Overhaul of option regime There was an overhaul of the option to tax regime in the mid 90s and various changes applied from 1 March 1995. The principal changes were as follows: •
The original rules required parades, precincts and complexes to be treated as one building when opting to tax. The references to parades and precincts were dropped from 1 March 1995 and the definition of complexes was confined to complexes consisting of units grouped around a fully enclosed concourse.
•
The VAT accounting rules were amended so that normal tax point rules applied to cover cases where a landlord had opted to tax for a date other than the beginning of a period for which rent was due.
•
The original rules meant that options could not be exercised on discrete areas of agriculture land. The option extended to any adjoining agriculture land, including buildings, in the same ownership. From 1 March 1995, it became possible to opt on discrete areas of agriculture land without the option affecting adjoining land.
•
Originally, not all options to tax had to be notified to Customs. Notification was not required where the taxable supplies were less than £20,000 a year. The rules now require all the options to tax to be notified to Customs.
•
Rules were introduced allowing revocation within three months or after 20 years from 1 March 1995.
•
The rules for allowing agreed retention of the option for buildings to be converted to dwellings etc were introduced on 19 March 1997.
•
There were no anti-avoidance rules until 30 November 1994. The 1994 rules were modified in 1997 and extended in 1999.
The original rules generally allowed no recovery of VAT incurred before the effective date of an option, if the owner had previously made exempt supplies in relation to the land in question. This rule was replaced by a requirement that an owner must seek Customs’ permission to opt. The permission rules applied to options effective from 1 January 1992. The permission rules were relaxed from 1 March 1995 to allow Customs to give automatic permission in certain cases. (See Chapter 4 for further analysis of the permission regime.)
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1 1 O P T I O N T O TA X – PA S T, P R E S E N T A N D F U T U R E
The present In 2003, Customs formed the option to tax unit. This is a national unit based in Glasgow and deals with all options made in the UK. Customs admit to underestimating the number of options the unit would have to deal with and this did cause problems with staffing which are being resolved. There are time delays however, particularly under the permission regime. Customs are operating the permission regime very stringently and where permission is required, businesses are advised to submit applications for permission well in advance of the effective date required. One of the major problems is where an option to tax requires first time VAT registration. As the option to tax notification and registration notification are dealt with by different offices this can cause unacceptable delays and duplicated questions. Businesses would be advised to send copies of the option to tax notification with the registration documents and visa versa. Due to the high instances of fraud where the fraudsters are exploiting VAT registration numbers, Customs treat each registration application with suspicion and caution. This too, whilst understandable, causes delays for businesses although Customs will ‘fast-track’ an application if the business makes out a good case for them doing so. In 2003, Customs issued a consultation document called VAT: Making Input Tax Recovery Fairer. It appears that most of the measures in the consultation document have been rejected or put on hold.
The future There has been a recent consultation document entitled The Future of the Option to Tax. This is a grand title for a document which relates mostly to revocation of the option. In 1995, legislation was introduced which gave landlords the right to revoke an option to tax after 20 years. As the option to tax regime itself was introduced in 1989, the first options available for revocation will be in August 2009. The concept of revocation has occupied Customs’ minds since 2000 and as 2009 rapidly approaches, legislation will be required to implement the revocation procedure. Customs have pledged to have draft legislation ready well before 2009 and have recently finished the consultation procedure; the result of which has not been announced at the time of writing.
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1 1 O P T I O N T O TA X – PA S T, P R E S E N T A N D F U T U R E
Consultation document The key points of the consultation document were: •
Is revocation required and how much use of revocation will there be?
•
What are the drivers for revocation?
•
What mechanism will be introduced for permitting revocation?
•
Foreseeable problems with revocation.
•
Other areas where revocation would be useful.
There is a suggestion in the document that Customs may withdraw revocation completely. Although it is envisaged that actual use of revocation may be sporadic, revocation gives businesses much needed flexibility. The process needs to be as simple as possible but, as in other areas, Customs will be keen to ensure that revocation is not used as an avoidance vehicle. It is likely that revocation will be used by businesses where an option is no longer needed. •
As a result of demands from exempt tenants.
•
Where the property is about to be sold.
•
Where the costs of being registered outweigh the benefits of registration.
•
Where simple mistakes and errors have been made when exercising the option in the first place.
It is likely that taxable tenants, as opposed to exempt tenants, will not wish their landlords to revoke elections. A tenant who makes wholly or mainly taxable supplies is normally happy to pay VAT and recover the VAT. This is because by accepting a positive VAT charge, a tenant is not incurring ‘hidden’ VAT charges. Hidden VAT charges occur where a landlord cannot recover VAT on service charge costs and passes this cost to the tenant as part of an exempt service charge. It could be that some tenants will insist on clauses in new leases which prevent a landlord from revoking an option. It is certain that Customs will not give businesses the opportunity to revoke an option without notifying Customs of the decision to revoke. There could be a limited automatic permission regime similar to the permission to opt rules. In which case, Customs would require information to be provided such as: •
a clear description of the property together with a plan, address and Land Registry title;
•
evidence of the original option;
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1 1 O P T I O N T O TA X – PA S T, P R E S E N T A N D F U T U R E
•
the reasons for wanting to revoke the option; and
•
the date that revocation is to take effect.
Customs will then have the opportunity to consider and investigate any avoidance motive in revoking an option. In conjunction with the Capital Goods Scheme, revocation would mean that the original input tax would become repayable on the date of revocation or at least the amount of input tax equal to the remaining intervals of adjustment would become repayable. It is unlikely that Customs will allow for input tax to be repaid in instalments over the remaining number of intervals when an option is revoked. The possibility of early revocations has been considered in the consultation document. Early revocation could be granted: •
where there is a grant of a new lease to a tenant who cannot recover all the input tax which he incurs; or
•
on the assignment of a lease from a fully taxable tenant to a tenant who is exempt from VAT.
Stringent rules will presumably be applied to early revocations to ensure that all requirements are complied with and there is no VAT avoidance motive. There are a number of foreseeable problems with revocation such as time delays in obtaining approval, issues of global options and rent demands issued before revocation where rent is paid afterwards. Although it is unlikely now, in the early days of the option to tax regime businesses opted on all properties even including those to be acquired in the future, known as global or blanket options. There may well be identification issues if a business wishes to revoke on some of the properties. Where there are time delays how will VAT be paid after revocation from rent demands issued before the revocation date is treated.
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Appendix Ten tips and ten traps ..........................................................................91
Appendix
Ten tips and ten traps Tips 1.
Consider opting in order to reclaim VAT
2.
Transfer ownership of part of a property to a subsidiary in order that one company can opt and another not opt as appropriate.
3.
Always consider the CGS and elect to avoid a clawback.
4.
Vendors should ensure if possible when selling an opted property for conversion to residential that they agree in writing with the purchaser that the option will remain valid.
5.
Ensure before opting that the terms of the lease allow you to charge VAT on rents.
6.
The transfer of going concern relief should be utilised where appropriate. If there is an element of uncertainty as to whether a sale will qualify and purchaser can recover the VAT charge, ensure at least one of the conditions for relief is not met.
7.
VAT chargeable on the sale of freehold of new commercial property may be avoided by granting a long lease (exempt if no option), but consider effect on input tax recovery.
8.
If intention is to convert a non-residential property to a residential property and grant short leases (exempt), maintain recovery of VAT on costs by selling freehold or granting long lease to a subsidiary (zero rated). The subsidiary can make the exempt supplies.
9.
Take care over tax points. Delay tax points where possible by issuing demands for payment rather than invoices.
10. Review partial exemption methods regularly to ensure recovery of VAT is maximised and the method is still appropriate and covers all activities.
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APPENDIX
Traps 1.
Forgetting that options have been made when selling or letting property. (If an agreement/contract is silent on VAT the consideration is VAT inclusive.)
2.
Contracting to purchase property and forgetting vendor can exercise an option and add VAT at any time before completion.
3.
Forgetting that the sale of a freehold of a commercial property is subject to VAT no matter how many times the property is sold within the three years from completion.
4.
Failing to fulfil all the conditions for transfer of going concern relief, so that VAT becomes chargeable.
5.
As a purchaser, paying VAT on a property where the transfer of going concern relief applies, thinking that it does not matter as VAT can be reclaimed.
6.
Overlooking a situation where the option is disapplied.
7.
Falling foul of CGS rules on sale of a property.
8.
Ignoring VAT implications of payments for surrenders, reverse surrenders, assignments etc.
9.
Forgetting that a rent free period in consideration of a tenant agreeing to carry out works can result in a VAT charge (if property opted).
10. Overlooking change of intention principles.
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Other specially commissioned reports BUSINESS AND COMMERCIAL LAW
The commercial exploitation of intellectual property rights by licensing
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1 85418 285 4 • 2001
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Expert advice and techniques for the identification and successful exploitation of key opportunities.
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how to identify and secure profitable opportunities
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strategies and techniques for negotiating the best agreement
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the techniques of successfully managing a license operation.
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Damages and other remedies for breach of commercial contracts ROBERT RIBEIRO
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1 85418 226 X • 2002 This valuable new report sets out a systematic approach for assessing the remedies available for various types of breach of contract, what the remedies mean in terms of compensation and how the compensation is calculated.
Commercial contracts – drafting techniques and precedents ROBERT RIBEIRO
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Inventions can be patented, knowledge can be protected, but what of information itself?
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Litigation costs MICHAEL BACON
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How to establish a sensible policy and whether or not you are entitled to insist on it as binding
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The degree to which you may lawfully monitor your employees’ e-mail and Internet use
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The implications of the Regulation of Investigatory Powers Act 2000 and the Electronic Communications Act 2000
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How the Data Protection Act 1998 affects the degree to which you can monitor your staff
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What you need to watch for in the Human Rights Act 1998
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TUC guidelines
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Example of an e-mail and Internet policy document.
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1 85418 241 2 • 2001 The rules and regulations are complex – but can be turned to advantage. The astute practitioner will understand the importance and relevance of costs to the litigation process and will wish to learn how to turn the large number of rules to maximum advantage.
International commercial agreements REBECCA ATTREE
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1 85418 286 2 • 2002 A major new report on recent changes to the law and their commercial implications and possibilities. The report explains the principles and techniques of successful international negotiation and provides a valuable insight into the commercial points to be considered as a result of the laws relating to: pre-contract, private international law, resolving disputes (including alternative methods, such as mediation), competition law, drafting common clauses and contracting electronically. It also examines in more detail certain specific international commercial agreements, namely agency and distribution and licensing. For full details of any title, and to view sample extracts please visit: www.thorogood.ws You can place an order in four ways: 1 Email:
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How to turn your HR strategy into reality TONY GRUNDY
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1 85418 283 8 • May 2003 The new four-part Code of Practice under the Data Protection Act 1998 on employment and data protection makes places a further burden of responsibility on employers and their advisers. The Data protection Act also applies to manual data, not just computer data, and a new tough enforcement policy was announced in October 2002.
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Successfully defending employment tribunal cases
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New ways of working STEPHEN JUPP
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Knowledge management SUE BRELADE, CHRISTOPHER HARMAN
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1 85418 230 7 • 2001 Managing knowledge in companies is nothing new. However, the development of a separate discipline called ‘knowledge management’ is new – the introduction of recognised techniques and approaches for effectively managing the knowledge resources of an organisation. This report will provide you with these techniques.
Reviewing and changing contracts of employment ANNELISE PHILLIPS, TOM PLAYER and PAULA ROME
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Email – legal issues £125
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1 85418 296 X • 2003 The Employment Act 2002 has raised the stakes. Imperfect understanding of the law and poor drafting will now be very costly.
360,000 email messages are sent in the UK every second (The Guardian). What are the chances of either you or your employees breaking the law? The report explains clearly:
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Ensure that you have a total grip on what should be in a contract and what should not
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Explain step by step how to achieve changes in the contract of employment without causing problems
•
Enable you to protect clients’ sensitive business information
•
Enhance your understanding of potential conflict areas and your ability to manage disputes effectively.
Applying the Employment Act 2002 – crucial developments for employers and employees AUDREY WILLIAMS
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How to establish a sensible policy and whether or not you are entitled to insist on it as binding
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How the Data Protection Act 1998 affects the degree to which you can monitor your staff
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TUC guidelines
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1 85418 253 6 • May 2003 The Act represents a major shift in the commercial environment, with far-reaching changes for employers and employees. The majority of the new rights under the family friendly section take effect from April 2003 with most of the other provisions later in the year. The consequences of getting it wrong, for both employer and employee, will be considerable – financial and otherwise. The Act affects nearly every aspect of the work place, including: •
flexible working
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family rights (adoption, paternity and improved maternity leave)
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European lobbying guide £129.00
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MANAGEMENT AND PERSONAL DEVELOPMENT
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1 85418 250 1 • 2001 The gap Far too few managers know how to apply project management techniques to their strategic planning. The result is often strategy that is poorly thought out and executed. The answer Strategic project management is a new and powerful process designed to manage complex projects by combining traditional business analysis with project management techniques.
For full details of any title, and to view sample extracts please visit: www.thorogood.ws You can place an order in four ways: 1 Email:
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