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Cite as: [2004] UKVAT V18610

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Danebridge Group Practice v Customs and Excise [2004] UK V18610 (17 May 2004)

VALUE ADDED TAX — supply by some general medical practitioners to themselves and other practitioners in partnership of surgery premises — waiver of exemption in order to recover input tax on construction costs — whether consideration for supply of premises limited to rent reserved by lease or to include payments made by NHS — NHS payments to be included in computation of consideration — appeal dismissed

MANCHESTER TRIBUNAL CENTRE

DANEBRIDGE GROUP PRACTICE

Appellant

- and -

THE COMMISSIONERS OF CUSTOMS AND EXCISE

Respondents

Tribunal: Colin Bishopp (Chairman)

Sitting in public in Birmingham on 17 March 2004

Philip Brunt of counsel, instructed by Alan Hinton & Associates, for the appellant

Nigel Poole of counsel, instructed by their solicitor's office, for the respondents

© CROWN COPYRIGHT 2004

DECISION

This is an appeal against an assessment of VAT of £60,382 and interest, notified on 25 June 2001. The appellant is a partnership of registered medical practitioners who, for the purposes of their VAT registration, carry on the business of constructing and supplying surgery premises in Northwich. The occupants of the premises are the partners in the appellant and some other registered medical practitioners, forming together a separate partnership carrying on practice as general medical practitioners. The former partnership (the appellant) is known as "Danebridge Group Practice", or the "Building Group"; the latter as "Danebridge Practice Group" or the "Medical Group." I shall use the latter terms.

I am required to deal only with a single issue of principle, that is whether the Commissioners' reasoning on which the assessment is based is correct, and am not required to consider the arithmetic or any other detail of the assessment.

The appellant was represented by Philip Brunt of counsel and the respondents by Nigel Poole, also of counsel. I heard evidence from Christopher Barratt, the senior partner of both the Building Group and the Medical Group, and I had the statements of Anthony Stanton, a general medical practitioner who has served for several years on British Medical Association committees and who has particular experience in the provision of medical practitioners' practising premises, and of Andrew Palethorpe, a civil servant employed by the Department of Health and whose evidence dealt with the manner is which general practitioners receive payments from that Department. I had also a comprehensive bundle of documents. I do not propose to deal with the evidence in detail since the facts of the case were not in dispute—what follows of a factual nature may be taken as my findings—and the real issue between the parties is a matter of interpretation and of law.

The Medical Group has, for some years practised from a site at London Road, Northwich, leased from the local authority. By about 1990, the surgery premises had become somewhat dilapidated and the then partners decided that they needed more modern accommodation. The solution they determined upon was to build a new surgery, with ancillary accommodation, on the car park which was in the grounds of, and served, the existing building, while continuing to practise from the building, and then to move to the new premises when they were completed. Thereafter, I understood, the old premises were demolished in order that the site could be used as a replacement car park.

The local authority was not willing to provide any financial assistance to the partners and it was necessary for them to make other arrangements for the funding of the construction of the new premises. It was decided that some of the partners—a few were close to retirement and unwilling to participate—would form a separate partnership which (after a number of changes in the partners over the years, as some have retired and others have been introduced) is the present appellant; its role was to obtain finance by borrowing from the General Practice Finance Corporation Limited, an organisation which provided interest-only loans to general practitioners for the purpose of acquiring suitable premises from which they could practise, and to procure the construction of the new premises which the appellant now leases to the Medical Group.

The site was secured by means of a new lease from the local authority, which incorporated the surrender of the existing lease. The new lease is for a term of 125 years from 1991 and was granted in return for the payment of a substantial premium and a ground rent of £4150 per annum, with upward-only reviews at five-yearly intervals. The new surgery premises were built and, on their completion, the Building Group granted a 99-year sub-lease to the Medical Group. It was apparent from the documents produced to me that part of the premises is not occupied by the Medical Group, but by a paramedical service, but I was not addressed on that point and I take it to be immaterial. The rent reserved by the sub-lease was £1 in the first year, but thereafter it was to be £50,000 per year, subject to upward-only review at seven-yearly intervals. The rent of £50,000 was fixed on the strength of an independent valuation; at each review the rent was to be revised following a similar valuation of a fair market rent. I understand there has been one review since the lease was granted and the annual rent now stands at £60,000 per year.

The Building Group elected to waive the exemption from VAT (in accordance with paragraph 2 of Schedule 10 to the Value Added Tax Act 1994) was thus able to recover the VAT it had incurred on the construction costs. It has correspondingly charged VAT on the rent it receives from the Medical Group, and has accounted to the Commissioners for that VAT. The motive behind the waiver of the exemption was the deferral, rather than the avoidance, of the burden of the VAT incurred on the construction costs; eventually, I understood, the tax payable with the rent will exceed the amount of input tax which the Building Group has recovered.

The Commissioners' case, and the basis of the assessment, is that the rent reserved by the lease from the Building Group to the Medical Group does not represent the entirety of the consideration received by the former from the latter for the supply of the premises. The true consideration, they say, should properly include an allowance paid by the NHS to medical practitioners, and which is known as "cost rent." The assessment represents the amount of additional tax for which, the Commissioners say, the appellant should have accounted in the period from 1 May 1998 to 30 April 2001; the amount assessed is the VAT fraction of the cost rent received in that period. The appellant's case is that the Commissioners have misunderstood the nature and the purpose of the cost rent: it does not, they say, represent any part of the consideration for the supply of the premises, but is merely an element of the remuneration received by its partners as medical practitioners. There is thus, they say, no scope for bringing it into account for the purpose of determining the appellant's output tax liability.

It was common ground that general practitioners are remunerated by the NHS, for which Health Authorities act as agents, by means of a combination of reimbursement of expenses and fees for services performed. There is no element of salary or retainer. Some of the reimbursements are, I understand, related precisely to the expenditure actually incurred, whereas others—of which the cost rent is one—are calculated by means of a formula. Amounts calculated in that fashion may exceed the actual expenditure, in which case the practitioner is quite at liberty to retain the excess; or they may fall short of the expense, in which case the practitioner must make up the difference from his own resources.

The circumstances in which cost rent is payable to a practitioner, and the method by which the amount due is calculated, are prescribed by rules made for the purpose of determining the remuneration of general medical practitioners by the NHS, and commonly known as the "Red Book". The rules are extensive and detailed. Those parts of the rules relevant here are to be found at paragraph 51 of the Red Book, although "paragraph" is rather a misnomer since it occupies as many as 59 pages. The Red Book is amended from time to time but it was agreed that none of the amendments which have been made to paragraph 51 affects the outcome of this appeal. I take the extracts which follow from the current version.

Paragraph 51 is entitled "Rent and Rates Scheme", and its purpose is described at sub-paragraph 51.2 in these terms:

"The purpose of the Scheme is to reimburse practitioners the rent and rates of practice accommodation by reference to what each practitioner pays or is deemed to pay. The arrangements for payment are set out in paragraphs 51.12-51.37 below. Alternatively, practitioners building new separate purpose-built premises, or producing their equivalent by structural alteration to premises, may be reimbursed a cost rent in accordance with the arrangements set out in paragraphs 51.50-51.58."

The paragraph goes on to make provision for various different types of payment, some of which may be payable at the same time as others while some are mutually exclusive. The NHS pays in this case, as examples of the former category, the ground rent (which is paid directly to the local authority) and the general and water rates. The rules show that a medical practitioner may claim rent, if that is what he actually incurs for the provision of his surgery, or a notional rent if he owns the premises himself; in each case the amount paid is assessed by reference to a market rent. Alternatively, but not cumulatively, he may apply for the "cost rent" which is at the centre of this case. The principle on which it is payable is set out at paragraph 51.50.1 of the Red Book as follows:

"Instead of a current market rent, a practitioner may apply for reimbursement related to the cost of providing separate purpose-built premises, or their equivalent, known as 'cost rent'. In all cases, reimbursement will only be offered to premises which comply with standards under the rent and rates scheme."

There follow further detailed provisions. There are, as one might expect, a number of formal requirements which must be satisfied if a practitioner is to receive cost rent payments but as these were, it was agreed, all satisfied here I need not dwell on them. Likewise I need not dwell on the formula for the calculation of the amount payable, save to comment that the cost rent is expected to exceed the market rent payable for the premises (and, as the documents produced by the parties showed, the market rent of the premises is determined from time to time in case it should be beneficial to the practitioner to make a claim for a market rent payment rather than the cost rent). In essence, as Dr Barratt put it in his evidence, the cost rent reimburses the interest payments which are made to General Practice Finance Corporation Limited. That is not how the Red Book describes the manner in which payments are calculated, and the Building Group's accounts for the year to 30 September 1998—the only set presented to me—show that there was, in fact, a modest shortfall in the amount received by comparison with the interest paid, but I accept that, even if by a different route, approximate reimbursement of interest payments will be achieved.

The rules which are set out in paragraph 51 of the Red Book refer throughout to the making of applications for cost rent by practitioners, and to the making of payments to practitioners. Mr Poole argued that this fact indicated that applications must be made by, and payments made to, practitioners as such—that is, in their capacity of medical practitioners, and not in their separate capacity of property owners or developers. That was, he said, consistent with Mr Palethorpe's evidence; his statement includes the sentence "These [cost rent] reimbursements are only payable where the GMP [general medical practitioner] or GMPs in question are 'in contract' with the NHS to provide General Medical Services in accordance with the 1977 [National Health Services] Act and relevant regulations made under that Act".

Dr Barratt's evidence was that he had made the application on behalf of all the Building Group partners in their capacity as medical practitioners. In order to become a Building Group partner, one has to be a Medical Group partner, and correspondingly a registered medical practitioner in contract with the NHS. Mr Brunt emphasised the fact that the scheme was designed to reimburse medical practitioners for the cost of providing their premises; but the amount paid (as indeed the Red Book makes clear) is dependent on the expenditure incurred, and the calculation is not affected by the number of practitioners in any practice. Thus, the amount received would have been the same if the application had been made by the Medical Group instead of the Building Group, or conversely by one partner alone. The application, had, however, been made by the Building Group and it was to the Building Group that the payments were made. I observe that the Health Authority's communications are addressed to "Dr Barratt C J and Ptns" and it is not clear from that description whether the authority was aware that the payments were being made to only some of the Medical Group partners. It was also apparent from the correspondence between the parties which was included in the bundle that the appellant, or at least its advisers, had for some time been under the impression that the payments were received by the Medical Group and handed over to the Building Group. I do, however, accept that, as Dr Barratt told me, the remittances were paid into a Building Group bank account.

I return at this point to the Building Group's accounts, which included income and expenditure figures both for the year to September 1998 and for the preceding year. As I have commented, they show that the cost rent received does not entirely cover the interest paid. The same is true of the reimbursements of water and general rates, though the shortfall is minimal. It is recorded that the Building Group also meets the cost of insurance, which the lease provides is to be reimbursed by the tenant; and of repairs, which the lease provides shall be borne (as to the exterior) by the landlord. It also meets the cost of heat and light, and cleaning, for which the lease makes no provision and which one might normally expect to be borne by the tenant. The lease expressly provides that the tenant shall bear the water and general rates; why, in those circumstances, the payments and the reimbursing receipts from the NHS are shown in the Building Group's accounts was not explained. I was provided with a further agreement made in 1993 between all of the then Medical Group partners which allows for the allocation of expenses to the Building Group, and for the differential sharing by the Medical Group partners of the rent payments, though it does not altogether explain the payments for heat, light and cleaning. The Building Group's income is shown by its accounts to be made up of the cost rent, the rent payable pursuant to the lease, the reimbursed rates and a small amount of interest. Overall there is a modest profit in each of the two years for which I had figures (which is shown elsewhere in the accounts to be divided between the Building Group partners) though an accumulated loss has been brought forward.

The critical issue identified by both counsel was whether the cost rent is payable by the NHS to the Building Group, as the appellant contends, or is in reality payable to the Medical Group (or, perhaps, to those of its partners who are also partners in the Building Group if the correct view is that only they applied for it), as the respondents argue. Mr Brunt's point was that only the Building Group partners had applied for the cost rent payments and correspondingly it must be to them that the payments were made. Since the money did not move from the Medical Group partners to the Building Group, the payments could not be the consideration for any supply made by the latter to the former. In my view, however, that is not the correct analysis of the facts of this case.

I have come to the conclusion that the rules set out in the Red Book, coupled with Mr Palethorpe's evidence, make it clear that cost rent payments are made only to medical practitioners as such. It is right, as Dr Barratt told me, that the calculation of the amount payable takes no account of the number of practitioners using the premises, but the Red Book rules defining the criteria which must be met if a building scheme is to be approved for cost rent purposes at all (particularly paragraph 51.3, which I do not need to set out here) make it very clear that factors such as the efficient use of space are of great importance. I prefer the view that the cost rent payments are made (or are intended by the NHS to be made) to the Medical Group and are diverted—I do not use the term in a critical sense—by the Medical Group to the appellant. But even if I am wrong in that conclusion, and the proper view is that the payments are made, and to the knowledge of the NHS, to the Building Group, it seems to me that the outcome of this appeal will be the same.

The contention which Mr Brunt made, that the Medical Group was required by the lease to pay a market rent and no more, does not seem to me to match the reality of what happened. It was quite clear from the evidence that the Building Group could not, and would not, have taken on the commitment of constructing the new premises and, in consequence, the liability of a large loan on which interest would be payable indefinitely into the future, unless the Medical Group had agreed that it should have the benefit of the cost rent. The annual amount payable by way of interest is shown in the 1998 accounts as £137,860, nearly three times the rent reserved by the lease. In my judgment it makes no difference how the benefit of the cost rent is obtained by the Building Group—that is, whether the payments of cost rent are made by the NHS to the Medical Group and passed on, or are made by the NHS to the Building Group with the acquiescence of the Medical Group; in either case the supply of the premises pursuant to the lease is being made in return for the aggregate of the rent reserved by the lease, and the cost rent payments. The appellant's argument, it seems to me, fails to take account of article 11(1) of the Sixth VAT Directive (77/388/EEC):

"The taxable amount shall be:

(a) in respect of supplies of goods and services … everything which constitutes the consideration which has been or is to be obtained by the supplier from the purchaser, the customer or a third party for such supplies including subsidies directly linked to the price of such supplies …".

If it is assumed that the cost rent payments are made directly to the Building Group, as the appellant argues, it is in my view inescapable that the cost rent is obtained from a third party, the NHS, and is paid for the supply of the premises (and is a payment without which that supply would not be made). Having reached that conclusion, I do not think it necessary to go on to ask whether the cost rent is a subsidy—as I think probable, though I was not addressed on the point—but if it is, it seems to me too that the condition of a direct link to the price of the supply is satisfied since, albeit by a formula, the cost rent is linked to the cost of making the supply, which is a critical factor in determining its price in the circumstances of this case.

Dr Stanton's evidence includes the comment that "I have never been aware of any situation in which Customs and Excise has sought to argue that VAT should be payable under the arrangements described in this case" but he does not indicate what description of those arrangements has been provided to him. Had the Medical Group itself arranged the construction of the new premises and borrowed in order to fund the work, it would not have been required to account for VAT on the cost rent, but it would not have been able to recover the VAT on the construction costs. It is the recovery of the VAT on those costs, and the consequential need for the Building Group to enter into a business relationship with the Medical Group pursuant to which it makes the taxable supply of the premises, which has led the Building Group into the trap of having to account for VAT on its entire income.

Though I have some sympathy with the appellant, I am satisfied that the appeal must be dismissed. Mr Poole did not seek a direction for costs in the Commissioners' favour.

COLIN BISHOPP

CHAIRMAN

Release Date: 13 May 2004

MAN/01/0552