Scottish Court of Session Decisions

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URL: http://www.bailii.org/scot/cases/ScotCS/2019/[2019]_CSIH_7.html
Cite as: 2019 SLT 213, [2019] STC 1298, [2019] BVC 7, 2019 GWD 6-84, [2019] CSIH 7, 2019 SC 304, [2019] ScotCS CSIH_7

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SECOND DIVISION, INNER HOUSE, COURT OF SESSION

Lord Justice Clerk

Lord Drummond Young

Lord Doherty

OPINION OF THE COURT

[2019] CSIH 7

XA13/18

delivered by LORD DRUMMOND YOUNG

in the appeal

BALHOUSIE HOLDINGS LIMITED

Appellant

against

A decision of the Upper Tribunal dated 20 October 2017

in an appeal by

THE COMMISSIONERS FOR HER MAJESTY’S REVENUE AND CUSTOMS

Respondent

Appellant: Simpson QC; Brodies

Respondent: Roxburgh; Office of the Advocate General

7 February 2019

[1] Schedule 8 to the Value Added Tax Act 1984 provides for the zero-rating of certain

forms of supply. In that Schedule, item 1 of Group 5 applies zero-rating to the first grant by

a person constructing a building intended for use solely for a relevant residential purpose of

a major interest in the building. Use of a building as a care home counts as a relevant

residential purpose. Where, however, the person to whom such a supply has been made

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disposes of its entire interest in the property or changes the use of the property to non-

residential within a period of 10 years from the date of completion of the premises,

paragraphs 35-37 of Schedule 10 to the 1994 Act in effect reverse the benefit of zero-rating

for that person, by providing that the original supply is to be treated as a taxable supply that

is not zero-rated. This is achieved by imposing a self-supply charge at the date of the

disposal or change of use.

[2] The appellant taxpayer is a company that carries on business as an operator of care

homes. It operates 25 care homes, mostly in the north-east of Scotland, and has formed a

VAT group with a number of subsidiaries. Those subsidiaries include Faskally Care Home

Ltd (“Faskally”) and Balhousie Care Ltd (“Balhousie Care”). In about 2010 the taxpayer

decided to construct three new care homes, including one situated in Huntly. The land, and

in due course the new home that was constructed in Huntly, belonged to Faskally. After the

building had been completed it was acquired by Balhousie Care. On the supply to

Balhousie Care, item 1 of Group 5 of Schedule 8 applied, and the supply was zero-rated. It

was thought, however, that it might be difficult for Balhousie Care to obtain bank finance,

and accordingly a sale and leaseback mechanism was used to finance the acquisition of the

care home. In March 2013 Balhousie Care sold the property to another concern, Target

Healthcare REIT (“Target”), and immediately thereafter leased it back from Target.

Balhousie Care continued to use the property as a care home.

[3] Following that transaction, HMRC decided that the appellant taxpayer as the

representative of the VAT group was liable to a VAT self-supply charge in consequence of

the disposal of the home to Target. That was intimated to the taxpayer by letter dated

24 June 2014. HMRC further determined to issue a notice of penalty assessment to the

taxpayer in consequence of its decision on the VAT liability, and intimated that decision to

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the taxpayer by letter dated 9 February 2015. The present appeal arises out of those two

decisions by HMRC. The critical question is, put shortly, whether a sale and leaseback

transaction such as that undertaken by Balhousie Care and Target amounts to the disposal of

the former company’s entire interest in the relevant premises for the purposes of paragraph

36(2) of Schedule 10 to the 1994 Act. If it amounted to a disposal of Balhousie Care’s entire

interest, it would give rise to a self-supply charge under the foregoing provision. The

taxpayer contends that it did not amount to a disposal of Balhousie Care’s entire interest

because, when the transaction was considered as a whole, its effect was to leave Balhousie

Care with the lease of the property, from which it continued to carry on the business of a

care home. HMRC, by contrast, contend that the transaction was a disposal of Balhousie

Care’s entire interest in the care home in consequence of the sale and disposition to Target.

For VAT purposes, HMRC claim, the relevant transaction was that transfer of the property,

and the fact that it was immediately followed by a leaseback was immaterial; the leaseback

was a distinct transaction from the sale.

[4] The taxpayer appealed against HMRC’s two decisions intimated on 24 June 2014 and

9 February 2015. On 31 May 2016 the First-tier Tribunal allowed the appeals. HMRC

thereafter appealed to the Upper Tribunal, which on 20 October 2017 reversed the decision

of the First-tier Tribunal and upheld the appeal. The taxpayer has now appealed to the

Court of Session against the decision of the Upper Tribunal. We should note that the appeal

to the First-tier Tribunal proceeded alongside two appeals by Faskally, but these do not form

part of the proceedings before the Court.

The findings in fact made by the First-tier Tribunal

[5] The First-tier Tribunal made detailed findings in fact, the most important of which

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have already been summarized. In about 2010 the taxpayer decided to build three new care

homes, including the home at Deveron Way, Huntly, which forms the subject of the present

appeal. The land on which the home was built, and after its construction the home itself,

belonged to Faskally, but following its completion it was acquired by Balhousie Care. At the

time it was considered that it would be difficult to obtain bank finance for the project, and it

was therefore decided to use a mechanism whereby properties were sold to another entity,

in the present case Target, and leased back by the operator of the care home. That

mechanism had been used previously and was said to provide funding for growth. A

funding arrangement of that nature was entered into in March 2013 in respect of the

property in Huntly and the two other new care homes. All three properties were by then

owned by Balhousie Care, and that company concluded missives with Target by means of

an offer dated 8 March 2013 made on behalf of Target which was accepted on an unqualified

basis by Balhousie Care on the same day. The missives provided for the sale of the

properties by Dalhousie Care to Target; the consideration for the Huntly property was

£4,007,561. The consideration was payable on 8 March 2013 or such other date as might be

agreed. The missives provided that at the date of entry Balhousie Care should give Target

entry to and vacant possession of the property, the giving of such possession being declared

an essential condition.

[6] The missives further contained an obligation by Target to grant leases of the three

properties to Balhousie Care with effect from the date of settlement; forms of lease were

appended. The leases provided that the properties should be used for an “Approved Use”,

which was defined as “use as a residential care home and/or nursing home” for the

provision of care as specified in certain legislation. The Huntly lease was for a term of

30 years. Balhousie Care had been in occupation of the three properties for some months

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prior to the sale and leaseback; finance for the property during that period had in effect been

provided by the main contractor who had built the property. The main contractor was

repaid out of the proceeds of the sale to Target. Following the completion of the sale and

leaseback transaction, Balhousie Care continued to occupy the care home and to use it for

the purposes of its business. No visible change occurred in the mode of operation.

[7] On 9 July 2013 HMRC carried out an examination of the group’s VAT records. This

was followed by a request for details of sale and leaseback transactions during the period of

the group’s VAT registration. The group’s agents, Grant Thornton, provided an analysis of

sale and leaseback transactions that had been undertaken in relation to the group’s design

and build projects; this analysis gave the Huntly property as an example. Further

correspondence ensued, and on 5 March 2014 HMRC stated that any further disposal of the

property by the taxpayer or, presumably, a member of its VAT group during the period of

10 years from practical completion would make them liable to what was described as “a

change of use ‘self-supply’ charge – on which they must account for VAT at the standard

rate”. Further correspondence ensued in which the parties’ respective positions were set

out. On 24 June 2014 HMRC issued their decision letter to the effect that, although the sale

of the property by Balhousie Care to Target was linked to the subsequent lease by

overriding agreement, the sale nevertheless constituted the disposal of Balhousie Care’s

entire interest in the property. While the taxpayer’s group had regained an interest by

entering into a long lease, that had to be viewed as a separate transaction. Consequently

HMRC concluded that the taxpayer was liable to a VAT self-supply charge, calculated as the

amount of VAT that would be payable on the purchase of the property by Balhousie Care

from Faskally, subject to adjustment for the separate disposal of a part of the property not

used for the purposes of the care home.

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The relevant legislation

[8] Section 30(2) of the Value Added Tax Act 1994 provides that a supply of goods or

services of a description falling within Schedule 8 to the Act should be zero-rated. Group 5

of Schedule 8 relates to the construction of buildings. Item 1 of that Group provides as

follows:

“The first grant by a person –

(a) constructing a building –…

(ii) intended for use solely for a relevant residential or a relevant charitable

purpose;…

of a major interest in, or any part of, the building, dwelling or its site”.

“Major interest” is defined in section 96(1) as, in Scotland, “the interest of the owner, or the

lessee’s interest under a lease for a period of not less than 20 years”. Thus the first grant of

ownership of a residential building is zero-rated. Care homes are accorded the same

treatment; note (4)(b) to group 5 provides that use for a relevant residential purpose means

inter alia use as a home, residential accommodation with personal care for persons in need

of personal care by reason of old age or disablement.

[9] Part 2 of Schedule 10 to the 1994 Act is headed “Residential and charitable buildings:

change of use etc”. So far as material, paragraphs 35-37 of that Schedule are in the following

terms:

“35. – Introductory

(1) This part of this Schedule applies where one or more relevant zero-rated

supplies relating to a building…have been made to a person (‘P’).

(2) In this Part of this Schedule –

‘relevant zero-rated supply’ means a grant or other supply which relates to a

building… intended for use solely for –

(a) a relevant residential purpose…

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and which, as a result of Group 5 of Schedule 8, is zero-rated (in whole or in

part);

‘relevant premises’ means the building (or part of a building) in relation to

which a relevant zero-rated supply has been made to P;

‘relevant period’, in relation to relevant premises, means – 10 years beginning

with the day on which the relevant premises are completed.

(3) Where P is a body corporate treated as a member of a [VAT group], any

reference in this Part… to P includes a reference to any member of that group.

36. – Disposal of interest or change of use following relevant zero-rated supply

(1) Paragraph 37 applies on each occasion during the relevant period when –

(a) there is an increase in the proportion of the relevant premises falling

within subparagraph (2) or (3), and

(b) as a result, the proportion of the relevant premises so falling (‘R2’) exceeds

the maximum proportion of those premises so falling at any earlier time in

the relevant period (‘R1’).

(2) The relevant premises fall (or part of the relevant premises falls) within this

subparagraph if P has, since the beginning of the relevant period, disposed of P’s

entire interest in the relevant premises (or part).

(3) The relevant premises fall (or part of the relevant premises falls) within this

subparagraph if –

(a) those premises do not (or that part does not) fall within sub-paragraph (2),

and

(b) those premises are (or that part is) being used for a purpose that is neither

a relevant residential purpose nor a relevant charitable purpose.

…

37. – Charge to VAT

(1) Where this paragraph applies, P’s interest, right or license in the relevant

premises held immediately prior to the time when the increase referred to in

paragraph 36(1) occurs is treated for the purposes of this Part of this Schedule as –

(a) supplied to P for the purposes of a business which P carries on, and

(b) supplied by P in the course or furtherance of that business

immediately prior to the time of that increase.

(2) The supply is taken to be a taxable supply which is not zero-rated as a result

of Group 5 of Schedule 8.

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(3) The value of the supply is taken to be –

(a) in the case of the first deemed supply under this paragraph, the

amount obtained by the formula –

(b) in the case of any subsequent deemed supply under this paragraph,

the amount obtained by the formula –

(4) For the purpose of sub-paragraph (3) –

(a) R1 and R2 have the meaning given by paragraph 36(1)(b),

(b) Y is the amount that yields an amount of VAT chargeable on it equal

to –

(i) the VAT which would have been chargeable on the relevant zero-

rated supply, or

(ii) if there was more than one supplier, the aggregate amount of the

VAT which would have been chargeable on the supplies,

had the relevant premises not been intended for use solely for a relevant

residential purpose or a relevant charitable purpose, and

premises were completed”.

[10] In these provisions, the event that triggers a charge to VAT is found in either sub-

paragraph (2) or sub-paragraph (3) of paragraph 36. They relate to P, who (paragraph 35(1))

is the person to whom the initial zero-rated supply has been made. Normally P will be the

owner of the premises supplied, although the definition of a “major interest” in section 96(1)

makes it clear that a long lease, in excess of 20 years, will be in the same position. In the

present case Balhousie Care, a company within the taxpayer’s VAT group (paragraph 35(3)),

owned the Huntly care home following the initial supply by Faskally. Sub-paragraph (2) of

paragraph 36 applies where P disposes of its entire interest in the relevant premises. By

themselves, those words are relatively straightforward. Sub-paragraph (3) applies where

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sub-paragraph (2) does not apply but the premises, or part of them, are used for a purpose

that, had it been the original purpose of the premises, would not have attracted zero-rating.

We consider the underlying purpose of these provisions subsequently (at paragraphs [25]-

[34] ). At present, it is sufficient to note that the two conditions are clearly distinct from each

other, both as a matter of substance (disposal in one case, change of use in the other) and

because of the wording of sub-paragraph (3)(a), which expressly differentiates between the

two sub-paragraphs.

[11] If the condition in either sub-paragraph (2) or sub-paragraph (3) is fulfilled,

paragraph 36(1) comes into operation in respect of either the whole of the premises or the

part of the premises that has been disposed of or has had its use changed. Paragraph 36(1)

brings paragraph 37 into operation. The effect of the latter paragraph is that a deemed self-

supply takes place by P to itself of the part of the property that has been disposed of or

whose use has changed, as the case may be. That supply is deemed to take place in the

course of P’s business, and it is a taxable supply which is not zero-rated (paragraph 37(2)).

The effect is to deny P the benefit of zero-rating in respect of the part of the property that has

been disposed of or whose use has been changed; as a result a charge to VAT will arise.

That charge will, however, be reduced by application of the formulae in paragraph 37(3),

which reduce the value of the deemed supply in proportion to the time that has elapsed

between the original zero-rated supply and the time of the disposal or change of use. This is

achieved by reference to the number of months, up to 120, that have elapsed following the

original supply. Thus no tax will be charged on a disposal if 10 years have elapsed since the

original zero-rated supply, and when a disposal occurs before the expiry of the 10-year

period the tax will be reduced proportionately according to the length of the period during

which P has retained ownership and preserved the original use of the property.

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The proper approach to the interpretation of VAT legislation

General principles of interpretation

[12] Counsel presented detailed submissions on the approach that should be adopted to

the construction of tax legislation. In large part this was based on the well-known line of

authorities that begin with the decision of the House of Lords in WT Ramsay Ltd v IRC,

[1982] AC 300, and continue with what is perhaps now the leading case in this area, Barclays

Mercantile Business Finance Ltd v Mawson, [2004] UKHL 51; [2005] 1 AC 684, and a series of

other cases until, most recently, UBS AG v Revenue and Customs Commissioners, [2016] UKSC

13; [2016] 1 WLR 1005 where the Barclays Mercantile principles were restated. Those

principles were developed, however, in order to respond to complex artificial schemes that

were generally devised to avoid the payment of income tax and capital taxes, and their

detailed application has normally been in that context. The case law on income tax and

other direct taxes is of limited assistance in dealing with VAT, which is an indirect tax levied

in a very different manner from income tax. Furthermore, the charge to VAT is based on a

number of fundamental principles, and respect for those principles is of great importance in

the application of the tax. Those principles are quite distinct conceptually from the Barclays

Mercantile principles; they are intended to secure the consistent imposition of tax on the

value added by a taxpayer’s economic activities. That requires a rigorously objective

approach to those economic activities; it is in that way that the fundamental principle of

fiscal neutrality is achieved.

[13] Nevertheless, certain basic features of the Barclays Mercantile principles are of

importance in all tax cases, and indeed more generally. These are stated in the speech of

Lord Nicholls of Birkenhead in Barclays Mercantile, at paragraphs [32]-[33]:

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“[32] The essence of the new approach was to give the statutory provision a

purposive construction in order to determine the nature of the transaction to which it

was intended to apply and then to decide whether the actual transaction (which

might involve considering the overall effect of a number of elements intended to

operate together) answered to the statutory description. Of course this does not

mean that the courts have to put their reasoning into the straitjacket of first

considering the statute in the abstract and then looking at the facts. It might be more

convenient to analyse the facts and then ask whether they satisfy the requirements of

the statute. But however one approaches the matter, the question is always whether

the relevant provision of the statute, upon its true construction, applies to the facts as

found….

[33] The simplicity of this question, however difficult it might be to answer on the

facts of a particular case, shows that the Ramsay case did not introduce a new

doctrine operating within the special field of revenue statute. On the contrary… it

rescued tax law from being ‘some island of literal interpretation’ and brought it

within generally applicable principles”.

The foregoing principles are restated in UBS, paragraphs [61]-[63]. Their effect is

summarized in the classic statement by Ribeiro PJ in Collector of Stamp Revenue v Arrowtown

Assets Ltd, [2003] HPCFA 46, at [35]:

“[T]he driving principle in the Ramsay line of cases continues to involve a general

rule of statutory construction and an unblinkered approach to the analysis of the

facts. The ultimate question is whether the relevant statutory provisions, construed

purposively, were intended to apply to the transaction, viewed realistically”.

[14] The principle of purposive construction is of course applied more widely; it is

probably not an exaggeration to say that it should be used in the interpretation of every sort

of legal text. So far as VAT is concerned, however, it is established by case law that, while

the legislation should be interpreted purposively, the transactions undertaken by the

taxpayer must be construed objectively, and it is not appropriate to have regard to the

taxpayer’s underlying purposes or intentions, except obviously to the extent that those are

manifested in the objective transactions that are carried out. The wording of a legal text

must be applied to a factual situation, and in performing that exercise it is obviously

essential to have regard to context. Context includes the legal context of the text, for

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example the whole of the statute in which it occurs and the general principles of law that

underlie that statute. It also includes the particular factual context in which that text is

applied (for example the transaction under consideration), and it includes the general

commercial or other context in which the text falls to be applied. Those principles are

relevant to the application of VAT legislation. In considering such legislation, however, it

also essential to have regard to the basic principles that underlie the tax.

General principles of VAT

[15] For present purposes, four general principles applicable to VAT are important. First,

VAT is a tax on economic activity, an expression that has been given a wide and objective

meaning. Consequently it is presumed that the tax will apply to every sort of economic

activity unless there is a specific exemption or a specific provision for zero-rating. Secondly,

the tax is transactional in nature: it applies to individual transactions in the chain of

transactions that ultimately results in the supply of a good or service to a consumer. This is

a fundamental feature of the structure of the tax, and it is of central importance to the

present case. The third principle is fiscal neutrality: that all economic activities, whatever

their purpose or results, are taxed in a wholly neutral way. At a practical level, this means

that, in the economic process of production and distribution of a good or service, VAT

should be charged on each of the successive transactions involved in the process on the

value added to the good or service by the particular taxpayer who is responsible for that

particular transaction. In this way the ultimate burden of the tax is passed on through

successive stages to the final consumer. It also has the result that it is immaterial how many

stages are involved in the production process, as it is only the value added at each stage that

is subject to tax. Largely because of these features, fiscal neutrality secures certainty and

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consistency in the imposition of VAT. The fourth principle is objectivity: in analysing and

construing the transactions at each stage in the process of production and supply of a good

or service, the court must adopt a strictly objective approach. This applies both to the

question of whether there is economic activity and to the analysis of the transactions that are

used by the taxpayer. In this way the certainty and consistency of the system is promoted.

Objectivity is of particular importance in the present case.

[16] VAT is charged on the supply of goods or services where it is a taxable supply made

by a taxable person in the course or furtherance of any business carried on by him where it is

not an exempt supply and is not zero-rated: Value Added Tax Act 1994, sections 1(1), 4 and

30. The supply must be for a consideration: ibid, section 5(2)(a). This represents the first of

the four general principles set out in the last paragraph: the tax is imposed on the economic

activities of a taxpayer. The fundamental basis on which the tax is imposed is pithily

expressed by the Advocate General in Case C-4/94, BLP Group PLC v Customs and Excise

Commissioners, [1995] ECR 1-983, [1996] 1 WLR 174, at paragraph 30:

“[T]he Community legislature, proceeding from an ideal image of ‘chains of

transactions’…, intended to attach to each transaction only so much VAT liability as

corresponds to the value accruing in that transaction, so that there is to be deducted

from the total amount the tax which has been occasioned by the preceding ‘link in

the chain’”.

This is the fundamental principle of fiscal neutrality, which is a central feature of VAT.

[17] That approach was followed as a matter of substance by the Court of Justice at

paragraphs 19-26 of its opinion, where it was held that for input VAT to be deductible the

goods or services on which it was charged must have a “direct and immediate link” with the

taxable supplies made by the taxpayer. Paragraph 30 of the Advocate General’s opinion was

referred to with approval in the House of Lords in Commissioners of Customs and Excise v

Robert Gordon’s College 1996 SC (HL) 6, at 11-12; [1995] STC 10 93, at 1099, per Lord Hoffman.

Page 14 ⇓

The Court of Justice in BLP referred to the terms of paragraph 5 of article 17 of the Sixth

Directive (now article 173 of the Principal VAT Directive), which referred to “transactions”

in respect of which VAT is or is not deductible, and continued (paragraph 19)

“The use in that provision of the words ‘for transactions’ shows that to give the right

to deduct [input VAT], the goods or services in question must have a direct and

immediate link with the taxable transactions, and that the ultimate aim pursued by

the taxable person is irrelevant in this respect”.

That emphasizes that VAT is a transactional tax, and that consequently each transaction in

the chain of supply must be examined separately to determine whether there is a direct and

immediate link between the supply made to the taxpayer and taxable transaction in respect

of which it is sought to deduct input tax.

[18] Furthermore, in BLP the Court of Justice held that the existence of a direct and

immediate link is to be determined objectively, and that the ultimate aim pursued by the

taxable person is irrelevant in that respect: ibid. The taxpayer in that case had contended

that its subjective purpose in carrying out the transaction in question (arranging for the sale

of certain of its shares) was material, but the Court held (at paragraph 24) that, if that were

correct,

“the authorities, when confronted with supplies which, as in the present case, are not

objectively linked to taxable transactions, would have to carry out inquiries to

determine the intention of the taxable person. Such an obligation would be contrary

to the system’s objective of ensuring legal certainty and facilitating application of the

tax by having regard, save in exceptional cases, to the objective character of the

transaction in question”.

Thus the transactions that form links in the “chain of supply” must be examined

individually and objectively in determining the application of VAT.

[19] In BLP the Court of Justice went on to consider the possibility of structuring

transactions in different ways, and the consequences of that for VAT. It stated:

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“25. It is true that an undertaking whose activity is subject to VAT is entitled to

deduct the tax on the services supplied by accountants or legal advisers for the

person’s taxable transactions and that if BLP had decided to take out a bank loan for

the purpose of meeting the same requirements, it would have been entitled to deduct

the VAT on the accountant’s services required for that purpose. However, that is a

consequence of the fact that those services, whose costs form part of the

undertaking’s overheads and hence of the cost components of the products, are used

by the taxable person for taxable transactions.

26. In that respect it should be noted that a trader’s choice between exempt

transactions and taxable transactions may be based on a range of factors, including

tax considerations relating to the VAT system. The principle of the neutrality of

VAT, as defined in the case law of the court, does not have the scope attributed to it

by BLP. That the common system of VAT ensures that all economic activities,

whatever their purpose or results, are taxed in a wholly neutral way, presupposes

that those activities are themselves subject to VAT”.

This passage makes it clear that it is the form of transaction chosen by the taxpayer that is

subject to VAT. The fact that a similar result could have been reached by structuring the

transaction in a different way is irrelevant. This is material to the present case. Target

provided finance to Balhousie Care using a sale and leaseback arrangement to provide

security for its financial involvement. Balhousie Care could have granted a standard

security in favour of Target in order to provide comparable security, and in that event the

benefit of zero-rating would have been preserved because there would have been no

disposal of the Huntly care home. That does not assist the taxpayer, however. Because for

VAT purposes transactions must be treated objectively, it is the actual transaction that was

carried out that must be considered, not a possible alternative.

[20] The discussion at paragraph 26 of the Court’s opinion in BLP refers specifically to the

fundamental principle of fiscal neutrality. It demonstrates the link between fiscal neutrality

and the other basic features of VAT, the transactional approach and the principle of

objectivity in the analysis of the transactions that make up the total economic process. It is

by analysing the transactions found at each stage in the economic process that the value

Page 16 ⇓

added by any particular taxpayer is ascertained, and that is to be done consistently, in such a

way as to ensure overall fiscal neutrality. For this reason a wholly objective approach must

be taken to the analysis of each transaction. Thus BLP is a clear affirmation of the basic

principles of VAT stated at paragraph [15] above.

[21] The fundamental structure of VAT, in particular its transactional nature, makes tax

avoidance more difficult than with income tax, corporation tax and capital taxes. The

transactional structure is strengthened by the principles of fiscal neutrality and objectivity.

Nevertheless, attempts are made to avoid VAT through the structuring of transactions.

These have not generally been dealt with using the approach found in Barclays Mercantile

Business Finance Limited v Mawson, supra. Instead the particular transactions that have been

employed are analysed on a strictly objective basis to discover whether they constitute

economic activity and, if they are economic in nature, to discover exactly what they achieve.

If, according to these criteria, the transaction amounts to the supply of goods or services, it is

subject to VAT. Likewise, so far as input VAT is concerned, if the transaction between the

taxpayer and its supplier is economic in nature and truly amounts to a supply of goods or

services, the VAT will be deductible. (This assumes, of course, that the output transaction is

not exempt).

[22] This approach is found in the important decision of the European Court of Justice in

Case C-255/02, Halifax PLC v Commissioners of Customs and Excise [2006] ECR i-1609;

[2006] Ch 387, a case that involved the analysis of a series of intra-group transactions that were

designed to enable the deduction of input tax in a situation where most of the supplies made

by the taxpayers were exempt. The Court began its analysis by considering general

principles of VAT, including the notions of supply and economic activity. It held (at

paragraphs 55 et seq)

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“55 [A]n analysis of the definitions of taxable person and economic activities

shows that the scope of the term economic activities is very wide, and that the term is

objective in character, in the sense that the activity is considered per se and without

regard to its purpose or results…

56 That analysis and that of the terms ‘supply of goods’ and ‘supply of services’

show that those terms, which define taxable transactions under the Sixth Directive,

are all objective in nature and apply without regard to the purpose or results of the

transactions concerned….

57 As the Court held in… Case C-4/94 BLP Group…, an obligation on the tax

authorities to carry out inquiries to determine the intention of the taxable person

would be contrary to the objectives of the common system of VAT of ensuring legal

certainty and facilitating the application of VAT by having regard, save in

exceptional cases, to the objective character of the transaction in question.

58 It follows that transactions of the kind at issue in the main proceedings are

supplies of goods or services and an economic activity… provided that they satisfy

the objective criteria on which those concepts are based.

59 It is true that those criteria are not satisfied where tax is evaded, for example

by means of untruthful tax returns or the issue of improper invoices. The fact

nevertheless remains that the question whether a given transaction is carried out for

the sole purpose of obtaining a tax advantage is entirely irrelevant in determining

whether it constitutes a supply of goods or services and an economic activity”.

Thus a properly objective analysis of the transactions used should disclose whether or not

VAT is payable or deductible, with an exception for tax evasion.

[23] A second question was presented to the Court of Justice by the national tribunal in

Halifax: whether the taxable person has no right to deduct input VAT where the transactions

on which that right is based constitute an abusive practice (paragraph 61). The Court

referred to the general principle that Community law cannot be relied on for abusive or

fraudulent ends, including transactions carried out “solely for the purpose of wrongfully

obtaining advantages provided for by Community law”, and held that those principles

applied to VAT (paragraphs 68-70). Nevertheless, in the application of Community

legislation certainty and foreseeability were important considerations, and a trader’s choice

between exempt transactions and taxable transactions might be based on a range of factors,

Page 18 ⇓

including tax considerations relating to the VAT system (paragraphs 72-73). The Court

continued:

“74 In view of the foregoing considerations, it would appear that, in the sphere of

VAT, an abusive practice can be found to exist only if, first, the transactions

concerned, notwithstanding formal application of the conditions laid down by the

relevant provisions of the Sixth Directive and the national legislation transposing it,

result in the accrual of a tax advantage the grant of which would be contrary to the

purpose of those provisions.

75 Second, it must also be apparent from a number of objective factors that the

essential aim of the transaction concerned is to obtain a tax advantage …”.

That is the general approach that should be followed to tax avoidance and evasion in

relation to VAT. It is obvious that it differs substantially from the approach found in

Barclays Mercantile and other cases on income tax and capital taxes. The reasons for this are

found in the general principles that govern the system of VAT.

[24] Moreover, the difference between the two approaches is apparent from an important

feature of the technique described in Ramsay, Barclays Mercantile and UBS. This is stated by

Lord Wilberforce in Ramsay, at [1982] AC 323-324, a passage quoted with approval by

Lord Nicholls in Barclays Mercantile at paragraph [30]:

“It is the task of the court to ascertain the legal nature of any transaction to which it is

sought to attach a tax or a tax consequence and if that emerges from a series or

combination of transactions, intended to operate as such, it is that series or

combination which may be regarded”.

The technique involves the aggregation of transactions if the intention of the taxpayer is that

they should operate as a series or combination. To do that, however, is fundamentally at

variance with the transactional nature of VAT, which involves looking at a series of

individual transactions and taxing them independently. Taxing transactions independently

is the manner in which the fiscal neutrality of VAT is achieved. Furthermore, the case law in

the Court of Justice is quite clear that the individual transactions must be considered

Page 19 ⇓

objectively, regardless of the intention or purpose of the particular taxpayer; that is apparent

from both BLP Group at paragraph 24 and Halifax at paragraphs 55-58 (cit sup). Such an

approach is inconsistent with the suggestion in Ramsay that a series or combination of

transactions “intended to operate as such” should be treated as a unity. For these reasons

we consider that the Barclays Mercantile approach is fundamentally inconsistent with the

basic principles upon which VAT is assessed.

Analysis of the legislation and its legislative purpose

[25] It is accordingly the general principles that govern liability for VAT, including the

right to deduct input tax, that must govern the present case. The particular legislative

provisions with which this case is concerned are paragraphs 35-37 of Schedule 8 to the Value

Added Tax Act 1994. The purpose of those provisions appears to us to be reasonably clear.

They deal with zero-rating, a concept described in section 30 of the 1994 Act. Under the

scheme of VAT in force in the United Kingdom certain categories of supply are zero-rated.

In that event, no VAT is charged on the supply but it is in all other respects treated as a

taxable supply. That has the effect that no VAT is payable on the zero-rated supply, but it is

still treated as a taxable supply; consequently input tax may be reclaimed in the same way as

for standard-rated supplies. This is a major difference from exempt supplies. The supplies

that are zero-rated are set out in Schedule 8 to the 1994 Act. They include food (excluding

products such as ice cream, confectionery, certain soft drinks and alcoholic drinks), books

and newspapers, transport and children’s clothing. Zero-rated supplies also include, in

group 5 of Schedule 8 to the 1994 Act, the first grant of a major interest in a building

intended for use solely for a relevant residential purpose; the latter expression includes use

as a care home: see paragraph [8] above.

Page 20 ⇓

[26] Zero-rating is thus a form of exemption from VAT with the important advantage, by

comparison with exempt supplies in the technical sense of that expression, that input VAT

can be reclaimed by the supplier. In normal market conditions, that should result in a

reduction in the price paid by the consumer as the VAT paid at stages of production and

distribution prior to the final sale can be reclaimed. The choice of supplies that are zero-

rated is obviously dictated by policy considerations. For example, food is a necessity and its

cost can be said to fall disproportionately on the poor by comparison with the rich because it

absorbs a greater part of their resources. Books promote learning and literacy; newspapers

promote knowledge of current affairs. The cost of transport and children’s clothing can be

said, as with food, to represent a necessity the cost of which falls disproportionately on the

poor. Residential property is another necessity, and it differs from commercial property in

that it is not used for any form of economic activity. Care homes are accorded the same

treatment as residential property because they amount in practice to the provision of

residential accommodation for those who through age or disability are unable to care for

themselves.

[27] Residential property and care homes differ in two important respects from most

other categories of zero-rated supply: the property acquired is normally of greater value,

and it remains in existence for many years. Those features give rise to a risk of abuse: a

building originally constructed as residential property might be converted into commercial

property relatively soon after construction. In that way a commercial enterprise, carrying on

economic activity, would be able to acquire premises that had originally been provided free

of any charge to VAT. The purpose of paragraphs 35-37 is in our opinion to prevent such

potential abuse, and they should be construed with that purpose in mind.

Page 21 ⇓

[28] Part 2 of Schedule 10 to the 1994 Act, which contains paragraphs 35-37, is headed

“Residential and charitable buildings: change of use etc”. Notwithstanding the heading, it is

clear from the terms of paragraph 36(2) that those provisions apply to the disposal of the

taxpayer’s interest in the building as well as to a change of use. Paragraph 35 states the

essential condition for the application of the later paragraphs: a zero-rated supply relating to

a building must be made to a person P. Paragraph 37 then imposes a self-supply charge on

P if the conditions in paragraph 36 are satisfied; the result of that is that P is deemed to have

made a taxable supply to itself which is not zero-rated: paragraph 37(2). Paragraph 37 goes

on to describe the manner in which the tax charge on the self-supply is calculated.

Paragraph 36 states the precise conditions that will trigger the self-supply charge. The

critical provisions for present purposes are found in sub-paragraphs (2) and (3), which we

have discussed in paragraph [10] above. Sub-paragraph (3) deals with use of the premises

or part of the premises for a purpose that is not a relevant residential purpose. It does not

apply to the present case because the care home continued to be used as such after the sale

and lease back transaction. Sub-paragraph (3) only applies, however, in cases where the

premises do not fall within sub-paragraph (2). Sub-paragraph (2) applies “if P has, since the

beginning of the relevant period [the period of 10 years since completion of the building],

disposed of P’s entire interest in the relevant premises”.

[29] The wording of sub-paragraph (2) appears to us to be quite clear. It applies to the

disposal of the premises. There is no requirement of a change of use; the latter is dealt with

separately in sub-paragraph (3), in cases where there has been no disposal. Moreover, there

are in our opinion sound reasons for imposing the self-supply charge on P in the event of a

mere disposal, without any change of use. Following disposal, the person who received the

initial zero-rated supply will normally have no control over the premises or their use. It is

Page 22 ⇓

possible, therefore, that the transferee could change the use of the premises from a care

home to an ordinary commercial purpose, such as an office or shop or warehouse. In that

event, the self-supply charge would be imposed by paragraph 37(1) on the original

transferee, but in respect of an act that was entirely outwith the control of the original

transferee. That is evidently an unsatisfactory result.

[30] In any event, zero-rating on the supply of care homes and other residential property

is an exemption from the ordinary rules of VAT. It is not surprising that the legislation

should restrict such exemptions, in a manner that reflects the basic legislative policy

underlying the system of VAT. If exemptions are not kept under control, the fundamental

principle of fiscal neutrality may be threatened. Furthermore, the transactional approach

requires that exemptions should be properly confined to the particular transactions to which

they relate, and the principle of objectivity, with its attendant certainty, requires that

effective criteria should be used to determine when an exemption does or does not apply.

Paragraphs 35-37 of Schedule 10 to the 1994 Act were enacted by the Value Added Tax

(Buildings and Land) Order 2011 to replace earlier provisions that had been found

unsatisfactory and uncertain in operation. In these circumstances it is hardly surprising that

an important legislative policy is that zero-rating should be clearly defined, to ensure

consistent treatment of taxpayers.

[31] Counsel for the taxpayer placed some reliance on the fact that in the present case

Balhousie Care was able to control the use of the property; in this way, he submitted, the

fundamental mischief struck at by paragraphs 35-37, namely use of the property for a

purpose other than a care home or other residential purpose, was not engaged.

Consequently, it was said, the benefit of zero-rating could be permitted to continue without

infringing the fundamental legislative objectives of those paragraphs. In our opinion that

Page 23 ⇓

submission should be rejected, for two reasons. First, paragraphs 35-37 are, as we have

explained, a limitation placed upon a type of exemption from VAT, zero-rating, and

effective criteria, complying with the basic VAT principles, must be used to determine the

extent of the exemption. Paragraph 36(2) restricts the exemption in any case where the

original transferee of a care home or other residential property disposes of its entire interest,

regardless of any change of use. Secondly, a sale and leaseback transaction involves the

disposal of the original owner’s heritable (real) interest in the property, albeit in exchange

for a lesser heritable interest in the form of a lease. The lease might nevertheless terminate

for a number of reasons, and in that event the original owner’s heritable interest would be

lost. In that event the original owner, Balhousie Care, could no longer control the use of the

property.

[32] We should also note one further aspect of the relevant legislation. Paragraph 37

deals with the calculation of the self-supply charge using the formulae in sub-paragraph (3).

Sub-paragraph (1) states that P’s interest in the relevant premises held immediately prior to

the time when paragraph 36(1) comes into operation (in the form of the event triggering the

deemed self-supply) is to be treated as supplied to P for the purposes of a business which P

carries on and as supplied by P in the course of that business. The assumption is that P has

supplied itself at the time of the original zero-rated transaction with the interest held

immediately before the time of the chargeable event. The wording of paragraph 37 thus

assumes that the person subject to the self-supply charge has held the property, or part of

the property, throughout the period from the time of the original zero-rated supply until the

event that triggers the charge to tax. That supports the view that paragraph 36(2) should be

applied in a straightforward fashion, to deal with any disposal of P’s entire interest in the

property.

Page 24 ⇓

[33] Finally, on this topic, we should note that counsel for the taxpayer placed some

reliance on HMRC’s manual VAT Construction, VCONST21500, where it is stated that

paragraph 36 was drafted as it is because the only person who can pay a “change in use”

charge is the person who received the zero-rated supply. Counsel submitted that in the

present case, because of the leaseback, the taxpayer would be able to pay the “change in

use” charge if that arose in future. On this document, we observe that the manual is not a

binding or authoritative statement of the law, and it is not binding on the court. Perhaps

more importantly, paragraph 36 is concerned to state provisions of general application. For

the reasons discussed in the last three paragraphs we consider that it is unsurprising that it

applies to any disposal of the property, because a disposal will usually take the property

outwith the control of the original transferee who obtained the benefit of zero-rating.

[34] For the foregoing reasons we are of opinion that the legislative purpose of

paragraphs 35-37, namely restricting the benefit of zero-rating in defined circumstances,

requires that full effect should be given to the terms of paragraph 36(2) and (3). The result is

that any disposal of the entire interest in relevant premises will trigger a self-supply charge

calculated in accordance with paragraph 37.

Application of the legislation to the facts of the present case

[35] We have set out the facts of the present case as found by the First-tier Tribunal at

paragraphs [2] and [5]-[7] above. The central feature is that Balhousie Care, a member of the

taxpayer’s VAT group, acquired the Huntly care home and then concluded missives with

Target. The missives provided for the sale of the care home to Target and the granting by

Target to Balhousie Care of a lease for a term of 30 years taking effect from the date of

settlement. The lease specified that the property should be used for an “Approved Use”,

Page 25 ⇓

which amounted to use as a residential care home or nursing home. The missives specified

a date of entry, and it was an essential condition that Balhousie Care should give Target

entry to and vacant possession of the property on that date.

[36] The argument for the taxpayer was in essence that the sale and leaseback should be

treated for the purposes of the VAT legislation, and in particular paragraphs 35-37 of

Schedule 10 to the Value Added Tax Act 1994, as a single transaction. The result, it was said,

was that Balhousie Care, the company that was in the position of P in paragraphs 35-37, had

not disposed of its entire interest in the relevant premises. Consequently the essential

condition in paragraph 36(2) was not satisfied.

[37] This argument was in large measure founded on the approach to the legislation

governing income tax and capital taxes found in cases such as Ramsay, Barclays Mercantile

and UBS. For the reasons stated previously, we are of opinion that this approach should not

be applied to VAT, which is an indirect tax of an essentially transactional nature. Instead, an

approach that is both transactional and objective must be followed in analysing transactions

for the purposes of VAT; that is essential to achieve the important objective of fiscal

neutrality. As a further basis for his argument, counsel for the taxpayer relied on the

proposition that the purpose of paragraphs 35-37, and paragraph 36 in particular, was to

deal with cases where the relevant premises were used for a purpose that was neither a

relevant residential purpose nor a relevant charitable purpose. That is certainly the test in

paragraph 36(3), but it fails to give effect to the distinct wording employed in

paragraph 36(2), which refers expressly to the case where P has “disposed of P’s entire

interest in the relevant premises”: see paragraph [10] above. It also fails to give effect to the

wording of paragraph 36(3)(a), which expressly indicates that that sub-paragraph, dealing

with change of use, does not apply in cases where sub-paragraph (2), dealing with disposal,

Page 26 ⇓

does apply: ibid. For these reasons we cannot agree that the overarching purpose of

paragraph 36 is to deal with cases where premises are used for a purpose that is not a

relevant residential purpose; paragraph 36 deals with disposal of P’s entire interest in the

relevant premises as well as use for a purpose that is not a relevant residential or charitable

purpose.

[38] Nevertheless, there remains the question of whether the sale and leaseback

transactions entered into by Balhousie Care amounted to the disposal of the entire interest in

the Huntly care home; that is the essential condition for the application of paragraph 36(2).

If the sale and leaseback were regarded as a single transaction, it could be said that its end

result was that Balhousie Care ended with a lease of the care home, which did not involve

the disposal of its “entire interest” in the premises. This raises the question: what for VAT

purposes is the relevant transaction? As we have already indicated, a transactional approach

is central in the application of VAT legislation, and determining the identity of each

transaction is a vital part of that analysis.

[39] In our opinion the sale and leaseback should be regarded as two distinct

transactions, the sale followed by the leaseback. As a matter of substance, considered

objectively, it is obvious that the sale and leaseback are distinct transactions. One is an

outright transfer of land made for payment of a consideration; the other is the grant of the

exclusive possession of land for a limited period, 30 years in this case, in exchange for a

series of periodic payments. Moreover, the lease could only take effect once the disposition

had been granted, as until then the landlord had no interest in the property. That result was

inevitable from the nature of the transaction, and it was in fact apparent from the terms of

the missives, which provided that at the date of entry Balhousie Care should give Target, the

disponee, entry to and vacant possession of the property (that being declared an essential

Page 27 ⇓

condition) and that Target should give Balhousie Care a lease with effect from the date of

settlement. These provisions recognized that the lease was a different transaction, and that

it could only take effect once Target was the heritable proprietor of the care home. Thus,

considered objectively, the sale and the leaseback serve different purposes and achieve

distinct results. The natural conclusion is that they represent separate transactions, as a

matter of substance.

[40] In this connection, the intention or purpose of Balhousie Care in entering into the

transaction is irrelevant. As we have already indicated, the legislative purpose is relevant to

the construction of the legislation, but the purpose of the taxpayer (or relevant member of

the taxpayer’s VAT group) is not relevant. Instead the transaction entered into must be

examined objectively. Thus it is immaterial that the taxpayer intended that the sale and

leaseback should function as in effect a security arrangement designed to raise finance for

the acquisition of the care home. We are accordingly of opinion that the sale and the

leaseback are as a matter of substance two entirely different transactions, the second being

dependent on the completion of the first. This would be reflected in the Land Register,

where two distinct transactions would inevitably be separately recorded. After the grant of

the lease, Balhousie Care continued to be entitled to occupy the property, but the right to do

so was dependent on the lease, not on their former ownership of the property.

[41] Once the sale is regarded as a distinct transaction from the leaseback, the application

of paragraphs 35-37 is straightforward. The sale of the property, and the consequent

disposition in favour of Target, divested Balhousie Care of its entire interest in the property.

Paragraph 36(2) therefore applies. Any other construction would in our opinion fail to

recognize the transactional structure of VAT, and would fail to give effect to a properly

objective analysis of the sale and leaseback.

Page 28 ⇓

Conclusion

[42] For the foregoing reasons we are of opinion that the taxpayer’s appeal should be

refused. We will accordingly uphold the decision of the Upper Tribunal.