Retirement and care housing and VAT traps
Developers and operators will know the care that has to be exercised in tax structuring retirement housing and care provision. VAT is an area which needs special attention.
Help is at hand this week with a ruling by the First Tier Tribunal upholding a taxpayer’s appeal against a VAT self-supply charge.
The issue at stake here concerned zero rating. The sale or lease of a building will be rated zero, standard or exempt, depending on the circumstances. Zero rating means that the developer can sell the building without charging VAT on the sale but, crucially, can recover VAT that he has paid out.
Zero rating for residential property will depend on whether the building is a dwelling – in which case the rating is based on design – or whether it is intended for a ‘relevant residential purpose’ – in which case the rating is dependent on use. This distinction will always be important for care homes and sometimes for retirement housing.
In the latter case, as one might expect, a change of use can trigger a charge to VAT. The legislation is contained in schedule 10 to the VAT Act 1994. The dispute concerned the meaning of that legislation. In the words of the Revenue & Customs Brief, Issue 49. 6/12/2012:
‘The current provisions are complex and… produce uneven tax consequences’.
A care home at Huntly in Scotland was built by Faskally Care Home Group Ltd (‘FC’), a subsidiary of Balhousie Holdings Ltd (‘BH’). For VAT reasons FC was not in the same tax group as BH and BH’s other subsidiaries. Following the development in 2010 it was decided to finance Huntly and two other homes owned by another BH subsidiary, Balhousie Care Ltd (‘BC’), by way of a sale and lease back.
The Huntly property was sold by FC to BC; BC then in 2013 sold all three properties to Target Healthcare REIT (‘Target’) and immediately took back long leases of all three properties.
The first transaction – the sale of Huntly by FC to BC – was treated as a VAT zero rated supply of a major interest in residential property. The relevant self-certification that the property was to be used for residential purposes was produced. So that transfer was zero rated.
The issue arose over what happened next to the Huntly property – the sale by BC to Target and the lease back from Target to BC. HMRC referred to its own VAT Guidance Note 708 which takes the view that where a person who is in receipt of zero rated supplies in respect of a building intended for residential purposes (BC in this case) disposes of their entire interest in those premises within 10 years, then that person must account for VAT on the original supply, as output tax.
In this case the amount of tax was assessed as £801,492. Added to this was interest of £24,308.26. This amount was described by Grant Thornton as a ‘potentially business ending issue’. The stakes could not have been higher.
The argument turned on an interpretation of paragraphs 35 to 37 of Schedule 10 of the Value Added Tax Act of 1994 and (i) whether a sale and lease back separated by a scintilla of time amounted to a disposal of the entire interest and (ii) whether such a disposal had to be accompanied by a change of use. Paragraph 35 is helpfully headed ‘Residential and Charitable Buildings: Change of Use etc.’ which would seem to offer a clue as to Parliament’s intentions.
HMRC referred to its own VAT guidance Note 708 which takes the view that as regards buildings completed after 1 March 2011, the taxable charge arises on a disposal of the building, regardless of whether or not it continues to be used for a qualifying purpose – residential in this case. They also argued that the sale was a distinct transaction from the lease back for tax purposes, notwithstanding they were linked contractually, and one could not happen without the other. For a scintilla of time BC had disposed of its entire interest.
The outcome, as indicated at the outset, was in favour of the tax payer which clearly had the sympathy of Court. The Tribunal took a robust and purposive approach in its interpretation: it did not accept that the entire interest was disposed of by BC, but rather that the sale and lease back was a composite transaction forming a commercial unity. And it added that the legislation is clearly intended to deal with the issue of ensuring that use for the relevant residential purposes continues.
This decision appears at first sight to be a victory for common sense. However the background and the questions it raises have to be considered. The law changed as of 1 March 2011 – the sale and lease back took place in 2013, and HMRC’s harsh views of the relevant law were well known 2 years before the transaction took place. Many operators in the sectors covered by ‘relevant residential use’ law e.g. care homes and student accommodation had structured their developments so as to prevent such a fact pattern ever arising and indeed banks at the time were lending according to whether the borrowers were at risk of such a self-supply charge. The taxpayers should not have been surprised that they were met with the response of HMRC.
The second question with a decision such as this is where will it end? The Tribunal held that the sale and lease back did not constitute a disposal of the entire interest of the taxpayer. The same could be said of a taxpayer having a contrived buy back option in any sale agreement – HMRC made this point but the Tribunal failed to address it. This is fertile territory for an appeal by HMRC.
Like all good stories this one has a moral. For nearly three years the Balhousie Group has laboured under the shadow of a business-ending issue which will have taken an enormous amount of management time, expensive legal fees and, no doubt, an emotional toll. With litigation like this the outcome is never certain, and with the prospect of an appeal the taxpayer’s troubles may not yet be over.
So the moral here: Beware VAT traps, and take tax advice early.