Balhousie - sale and leaseback does not constitute disposal of 'entire interest' in property

In Balhousie Holdings Ltd v HMRC [2021] UKSC 11, the Supreme Court allowed the taxpayer’s appeal, holding that a sale and leaseback was not a disposal of the taxpayer’s ‘entire interest’ in a care home and accordingly HMRC was not entitled to claw back the benefit of the VAT zero-rating that had applied when the taxpayer acquired the home.

Background

The taxpayer, Balhousie Holdings Ltd (Balhousie) was an operator of care homes. In 2013, it built a new care home and sold it to one of its subsidiaries, Balhousie Care Ltd (Care). The sale was zero-rated for the purposes of Item 1, Group 5, Schedule 8, Value Added Tax Act 1994 (VATA 1994), which provides for the zero-rating of the first grant by a person 'constructing a building … intended for use solely for a relevant residential or a relevant charitable purpose … of a major interest in, or in any part of, the building, dwelling or its site'.  

Subsequently, Care entered into a sale and leaseback transaction in respect of the care home to a Real Estate Investment Trust (REIT), conveying its interest in the home to the REIT and immediately taking an inferior lease of the home.  

Paragraphs 36 and 37, Schedule 10, VATA 1994, provide for a clawback of the benefit of zero-rating if either of two events takes place within ten years of the building's completion. The first (under paragraph 36(2)) is if the original recipient of the zero-rated supply disposes of its entire interest in the building; the second (under paragraph 36(3)) is if there is a change of use of the building from a qualifying use (ie a relevant residential or relevant charitable purpose) to a non-qualifying use. The clawback is effected by a self-supply transaction at standard rate that occurs immediately prior to the disposal, or change of use, as the case may be. 

The dispute in this case was whether, by entering into the sale and leaseback, Balhousie had disposed of its entire interest in the care home. 

Balhousie was successful in its appeal before the First-tier Tribunal, which agreed with it that the sale and leaseback transaction should not be viewed as a disposal of its entire interest. However, the Upper Tribunal allowed HMRC's appeal and the Inner House of the Court of Session agreed with it, concluding that while the legislation should be interpreted purposively, the transactions undertaken by Balhousie should be construed objectively and it is not appropriate to have regard to the taxpayer's underlying purpose or intentions, except to the extent that those are manifested in the objective transactions that are carried out. In the view of the Court of Session, since the entire interest acquired by Care had been disposed of (even if the operation of the care home was preserved by the grant of a long lease of the home simultaneously with the transfer of Care's interest to the REIT), it followed that the clawback provisions contained in Schedule 10 applied. Balhousie appealed to the Supreme Court.

Supreme Court judgment

The appeal was allowed.

The Supreme Court disagreed with the Court of Session. Lord Briggs, giving the lead judgment, said that the purpose of the clawback in paragraph 36, Schedule 10, VATA 1994 (taken together with the tapering provision in paragraph 37), was to claw back the benefit of zero-rating 'by reference to the point in time at which, because of a change in the use of the relevant premises (or part of them) … the benefit of the relief can no longer flow through to the intended beneficiaries as consumers'. In his view, HMRC's submission that a disposal of ownership even accompanied by the simultaneous conferral on the disposing party of a lease, faced 'insuperable difficulties'. HMRC was still able to monitor whether the premises were being put to a qualifying use; the question of who had effective control over the use of premises subject to a lease depended entirely on the terms of the lease. The recipient of the zero-rated supply needed no encouragement to ensure that the premises remained in a qualifying use, since paragraph 36(3) imposed a clawback if the use changed, regardless of any alienation of the premises.  

Lord Briggs said that paragraph 36(2) was concerned with avoiding the large tax benefit of zero-rating upon a person who is not prepared to commit to the project of creating and operating a building for a specified socially desirable residential use for a substantial period of time after its completion, and that in order for the original recipient of the supply to have disposed of its 'entire' interest in the premises it was necessary for it to no longer have any interest in the premises at all.  

Lady Arden gave a concurring separate judgment. While she agreed with Lord Briggs' conclusion that Balhousie's appeal should be allowed, she reached her decision by a different route. She first considered whether the conditions for zero-rating engaged the principles of EU law, and concluded that they did. In light of this conclusion, she decided that following the decision of the CJEU in Mydibel v État belkge (C-201/18), which was released shortly after the Court of Session decision in the present case, a sale and leaseback transaction was to be treated for VAT purposes as a single supply and that accordingly Care had not disposed of its entire interest in the care home.  

Comment 

The question of whether a sale and leaseback constitutes a disposal for VAT purposes is relevant in other contexts besides zero-rating, such as for the capital goods scheme. Although the CJEU confirmed  in Mydibel that a sale and leaseback should not be treated as a disposal, HMRC has previously indicated that it does not regard that judgment as applying in the UK. Given the reliance Lady Arden placed on Mydibel in reaching her decision, it will be interesting to see whether HMRC maintain that position.

The different reasoning employed by Lord Briggs and Lady Arden is striking, perhaps suggesting that either Lord Briggs was uncomfortable with relying too heavily on EU law (in light of the UK's departure from the EU), or that Lady Arden was not prepared to extend the substance-over-form doctrine (that has become a touchstone of the UK courts' interpretation of direct tax legislation) too far into the realm of VAT, which has its own doctrine of abuse of law. Time will tell whether, and if so to what extent, EU-based reasoning continues to be applied explicitly by the courts when determining VAT issues where an alternative route, based purely on domestic jurisprudence, is also available.

The judgment can be viewed here.