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Abbey National Plc v Customs and Excise [2004] UKVAT V18666 (21 June 2004)

18666

VALUE ADDED TAX – sale and leaseback - the Appellant sold a number of freehold and leasehold properties to an independent third party who leased them back to the Appellant - the assignments of some shorter leases to the third party required the consents of the landlords - in the absence of such consents the Appellant assigned to the third party the economic benefits and burdens of these leases - the Appellant remained in occupation of the premises and paid a fee to the third party which was similar to the rent which would have been charged under a formal lease back - whether the supply by the third party to the Appellant in return for the fee was an exempt supply of the leasing or letting of immovable property – no – or whether the fee paid by the Appellant to the third party was for agency and property management services – yes partly and partly to enable the third party to pay the rent due from the Appellant to its landlord – before and after the transfer the Appellant underlet some shorter leasehold properties and transferred to the third party the right to receive the rents from the under tenants – whether those rents "accrued" to the third party so that the exempt supplies to the under tenants were then made by the third party – yes –or whether the exempt supplies to the under tenants were made by the Appellant and the rents paid to the third party represented consideration for standard-rated supplies of agency and property management services made by the third party to the Appellant – no - appeal allowed in part – EC Sixth Council Directive (77/388/EEC) Art 13B(b); VATA 1994 Sch 10 para 8(1)

LONDON TRIBUNAL CENTRE

ABBEY NATIONAL PLC

Appellant

- and -

THE COMMISSIONERS OF CUSTOMS AND EXCISE

Respondents

Tribunal: DR NUALA BRICE (Chairman)

MRS L M SALISBURY

Sitting in public in London on 5-7 May 2004

David Goy QC with Claire Simpson of Counsel, instructed by Peter Mason, the Appellant's Head of VAT, for the Appellant

Kenneth Parker QC with Timothy Ward of Counsel, instructed by the Solicitor for the Customs and Excise, for the Respondents

© CROWN COPYRIGHT 2004

DECISION

The appeal

Abbey National Plc (the Appellant) appeals against two decisions of Customs and Excise both contained in a letter dated 7 March 2003. The first decision was that, after the Appellant had assigned all the economic benefits and burdens of some leases to a third party, remaining in occupation of the premises and paying a fee (called a principal fee) to that third party, the supply by the third party to the Appellant was not an exempt supply of the leasing or letting of immovable property but a standard-rated supply of agency and property management services. The second decision was that, after the Appellant had transferred to the third party the benefit of some under leases granted by the Appellant, the rents due to the Appellant from the under tenants remained the property of the Appellant and, when paid by the under tenants to the third party as provided by the transfer, were consideration for standard-rated supplies of agency and property management services made by the third party to the Appellant.

We were informed that the amount of tax at issue in the appeal was in the region of £400,000 for each year after December 2000.

The legislation

Article 13B of the Sixth Council Directive (77/388/EEC) provides that Member States shall exempt … :

"(b) the leasing or letting of immovable property …"

Section 51 of the Value Added Tax Act 1994 (the 1994 Act) provides that Schedule 10 shall have effect with respect to buildings and land. Paragraph 8(1) of Schedule 10 provides:

"8(1) Where the benefit of the consideration for the grant of an interest in, right over or licence to occupy land accrues to a person but that person is not the person making the grant-

(a) the person to whom the benefit accrues shall for the purposes of this Act be treated as the person making the grant; … ."

The issues

The Appellant is a well-known high street bank and makes mostly exempt supplies. It is therefore only able to recover as input tax a small proportion of the tax it pays on supplies made to it. The issues in the appeal relate to the question as to whether the Appellant received standard-rated supplies of agency and property management services (as argued by Customs and Excise) or (in one case) exempt supplies of the leasing or letting of immovable property and (in the other case) no supplies at all (as argued by the Appellant).

In 2000 the Appellant wished to sell a number of freehold and leasehold properties to an independent third party who would lease them back to the Appellant. The assignments of some of the leases required the consents of the landlords. In the absence of such consents the Appellant assigned to the third party (in what was called a virtual assignment) all the economic benefits and burdens of those leases. The Appellant remained in occupation of the properties and paid a principal fee to the third party of an amount which was similar to the rent which would have been charged if a formal lease back of the premises had been made by the third party to the Appellant. Under the virtual assignment it was agreed that the third party would pay the rents due form the Appellant to the landlords.

The first supply in dispute concerns the supply made to the Appellant by the third party in return for the principal fee. The Appellant argued that the principal fee was consideration for the Appellant's continuing occupation of the properties and so the supplies made to it by the third party were supplies of "the leasing or letting of immovable property" within the meaning of Article 13B(b) and so were exempt supplies. Customs and Excise argued that the Appellant's right of occupation derived from the leases themselves and so the principal fee paid by the Appellant to the third party was paid for supplies of agency and property management services which were standard-rated supplies.

The second supply in dispute concerns the rents of the underlet properties. Before and after the virtual assignment the Appellant granted under leases of some of the properties and by the virtual assignment assigned to the third party the right to receive the rents. The rents were then paid by the under tenants to the third party. The Appellant argued that the rents "accrued" to the third party within the meaning of paragraph 8(1) of Schedule 10 and so the third party was to be treated as the person who had granted the under leases with the result that the rents received by the third party were consideration for the making of exempt supplies by the third party to the under tenants. Customs and Excise argued that the Appellant retained the right to receive the rents from the under tenants and so it was the Appellant who made exempt supplies to the under tenants and when the rents were paid to the third party they constituted consideration paid by the Appellant to the third party in return for standard-rated supplies of agency and property management services.

Thus the issues for determination in the appeal were:

(1) whether under the virtual assignment the supply by the third party to the Appellant was an exempt supply to the Appellant of the leasing or letting of immovable property within the meaning of Article 13B(b) (as argued by the Appellant) or whether the principal fee was paid for standard-rated supplies of agency and property management services (as argued by Customs and Excise); and

(2) whether under the virtual assignment the rents of the under leases "accrued" to the third party within the meaning of paragraph 8(1) of Schedule 10 so that the third party was to be treated as the person who made the exempt supplies to the under tenants (as argued by the Appellant) or whether the rents of the under leases belonged to the Appellant and when paid by the under tenants to the third party constituted consideration paid by the Appellant for standard-rated supplies of agency and property management services (as argued by Customs and Excise).

The evidence

Three bundles of documents were produced and a fourth bundle which contained witness statements. Oral evidence was given on behalf of the Appellant by Mr Russell Joseph Deyell, who was, at the relevant time, the Appellant's Finance Project Manager responsible for the sale and leaseback; Mr Nicholas Guy Roberts, the Partnership Development Manager for the Appellant's property management division; and Mr Shafqat Malik FCCA AMCT the Financial Controller of Mapeley Limited.

The facts

From the evidence before us we find the following facts.

The sale and lease back

For the purposes of its business the Appellant came to own a large number of properties both freehold and leasehold. By the late 1990's the Appellant owned approximately 1,000 such properties of which about half were freehold and half leasehold. Some of the freeholds were very valuable and some of the leaseholds were virtually worthless tenancies of shop-like premises occupied by the Appellant's branches. We saw a typical lease dated 23 December 1993 under which a landlord leased to the Appellant certain premises for the term of twenty-five years. The lease contained a covenant by the Appellant with the landlord "not to mortgage charge assign transfer underlet or part with the whole or underlet the whole or part of the demised premises without the consent of the landlord such consent not to be unreasonably withheld." The lease also contained a provision that if there were any breach of the covenants on the part of the Appellant the landlord could re-enter the demised premises and the term should cease.

In early 2000 the Appellant considered a sale and leaseback arrangement under which it would sell most of its property portfolio (freeholds and leaseholds) to a third party who would then lease back to the Appellant such of the premises as the Appellant wished to occupy. The commercial advantages of such an arrangement for the Appellant were: that it released capital which could be invested elsewhere in the business; that it transferred the property risk to a third party; and that it aligned the Appellant's property liability more closely with its business needs because it permitted the Appellant to vacate leasehold property which was surplus to its needs before the term of the lease expired. It was also intended that, after the transfer of the properties, the new owner would manage the whole portfolio. Negotiations were held with a number of parties and ultimately agreement was reached with Mapeley Columbus Limited (Mapeley).

There was no difficulty in the Appellant transferring the freehold properties to Mapeley nor was there any difficulty in the Appellant assigning its long leasehold interests to Mapeley where there was no requirement to obtain the consent of the landlord to such assignment. However, two difficulties arose in respect of those shorter leases where the consent of the landlord to the assignment was required. First, a number of such consents was required and they would take more time to obtain than was available. Secondly, it was thought to be unlikely that the landlords would consent to assignments to Mapeley which was a new company without a track record of financial strength. In order to overcome these difficulties the concept of a virtual assignment was developed. Under such a virtual assignment the Appellant would transfer all the economic benefits and burdens of the shorter leases to Mapeley and the Appellant would remain in occupation of the premises and would pay a principal fee to Mapeley which was similar to the rent it would have paid if there had been a formal lease back. Most of the shorter leasehold properties were the subject of the virtual assignment.

The legal position of the Appellant and Mapeley was regulated by a Master Agreement dated 18 October 2000.

The Master Agreement

Under the Master Agreement, in return for the consideration of £457,250,000, the Appellant agreed to sell its properties (freehold and leasehold) to Mapeley and in return Mapeley agreed to grant to the Appellant leases for such of the properties as the Appellant wished to occupy, for such terms as the Appellant wished, and at a current market rent which escalated every six months by a fixed percentage (3% per annum). We call this the indexed rent. Of the total consideration a nominal £1 was paid for each lease. The Master Agreement commenced on 25 December 2000 and was for a term of twenty years. The following clauses of the Master Agreement are relevant:

Clause 4 provided that the Appellant agreed to sell and Mapeley agreed to buy the transferred properties. On the completion date the Appellant would transfer the freehold properties and would assign the leasehold properties to Mapeley. If, for any reason, an assignment were not completed on the completion date, then the Appellant would execute a virtual assignment pending completion of the lawful assignment of that property to Mapeley.

Clause 8 provided that Mapeley agreed to grant leases of the transferred properties to the Appellant each for a term which was the lesser of (a) a period expiring on the Hold Date for those premises or (b), in the case of a property with a lease from a landlord, the remaining term of that lease less three days. The Hold Date was the date upon which the Appellant wished to cease to occupy the property. There was a separate Hold Date for each property which was stated in Schedule 10 of the Master Agreement.

Schedule 10 was divided into three parts. Part I listed the freehold properties the subject of the Master Agreement. Part II listed the long leasehold properties where the consent of the landlord to assign or underlet was not required. Part III listed properties where the landlord's consent to assign or underlet was required. It excluded vacant properties. In respect of each property a different Hold Date was specified.

Clause 8.4 provided that, in relation to properties mentioned in Schedule 10 Part III, the Appellant would occupy the premises pursuant to the virtual assignment until such time as the assignments were completed.

Clause 8.7 provided that the standard occupancy regulations (as set out in Schedule 11) should be the occupancy regulations for the purposes of the leases by Mapeley to the Appellant and to the occupancy of the premises the subject of the virtual assignments. However, if the Appellant was in occupation of the premises then the Abbey National occupancy regulations (as set out in Schedule 12) applied.

Schedule 11 contained the standard occupancy regulations which applied where the Appellant was not in occupation of the premises. These regulations contained obligations by the tenant to pay rent and outgoings and other obligations similar to the tenant's covenants normally contained in a lease (for example, the Appellant had to have the consent of Mapeley before carrying out alterations). The standard occupancy regulations also contained obligations on the part of Mapeley (called the landlord) which were similar to the landlord's covenants normally contained in a lease. Appendix 1 of Schedule 11 contained the provisions for increasing the rents or the principal fees.

Schedule 12 contained the Abbey National occupancy regulations which applied if the Appellant was in occupation of a property. They were similar to the standard occupancy regulations with some changes; for example, under these regulations the Appellant could carry out alterations after giving notice to Mapeley.

Clause 8.16 provided that, in respect of vacant properties, the Appellant was a licensee of Mapeley and for a period of twelve months was obliged to pay a licence fee to Mapeley. However, clause 8.17 provided that Mapeley was at liberty during that twelve month period to let, underlet or otherwise deal with the vacant properties and any rent or other monies receivable by Mapeley from a third party in that period belonged to Mapeley absolutely.

Clauses 11 to 22 provided that Mapeley would provide estate property management services to the Appellant including lease renewals and the collection of payments of rent.

Clause 11 provided that Mapeley should retain the services of Nelson Bakewell (who had previously provided estate property management services to the Appellant) for the purpose of the performance of the estate management services mentioned in the agreement. A summary of estate management standards was set out in Schedule 14 and those standards applied to all of the properties the underject of the Master Agreement, including freehold and long leasehold properties as well as those the subject of the virtual assignment.

Clause 16 provided that Mapeley covenanted with the Appellant that where any lease from a landlord was due to expire before the Hold Date then Mapeley would use its best endeavours to obtain a new lease in its name on terms that Mapeley could then grant a lease to the Appellant.

Clause 17 provided that, if a lease renewal were not available, Mapeley had to find alternative premises for the Appellant.

Clause 18 provided that the Appellant had to pay Mapeley one rent for each quarter and any service charge due in that quarter. Thus the Appellant was obliged to pay Mapeley a single sum each quarter for all properties, whether freehold or long leasehold with a lease back, or a virtual assignment with continuing occupation. Mapeley was liable to pay all the rates in respect of all the properties.

Clause 19.1 provided that the Appellant could vacate any premises on the Hold Date without compensation or prior notice to Mapeley but "must give vacant possession" of the relevant premises. If the Appellant wished to vacate any premises prior to the Hold Date then it had to give notice to Mapeley and pay compensation. It also had to give vacant possession of the premises to be vacated on or before the date it wished to vacate.

Clause 23 contained provisions about the expiry of the Master Agreement which was after a period of twenty years. On expiry the Appellant had the option to buy back the freehold interests of some specified properties or to remain in occupation with the agreement of Mapeley. There was also an option to terminate the virtual assignment.

Schedule 2 paragraph 4 provided that, where a transfer or assignment of any transferred property was not completed on the completion date because of the need to obtain the consent of any landlord, then the Appellant and Mapeley should enter into a virtual assignment in respect of such properties. It also provided that until completion took place, "where legally possible", the Appellant should hold the benefit of any under lease in trust for Mapeley in all respects. It went on to provide that Mapeley should act as the agent of the Appellant for the purpose of obtaining the consents of the landlords to the assignments or transfers and should use its reasonable endeavours to obtain the consents of the landlords to the assignments or transfers. The Appellant was entitled to identify any leasehold properties which had been vacated by the Appellant where Mapeley had to attempt to seek and obtain the consent of the landlords so as to enable the assignment of the relevant leasehold property to be completed.

Schedule 2 paragraph 13 provided that the Appellant irrevocably appointed Mapeley to be its agent to act on its behalf and in its name in all dealings connected with the landlords for the purpose of any aspect of the Master Agreement.

Schedule 2 paragraph 22 provided that Mapeley was responsible for all payments of rent becoming due to landlords after the commencement date.

Schedule 5 contained a form of virtual assignment. The virtual assignment was executed on 24 October 2000 and is considered in more detail below.

Schedule 6 contained forms of powers of attorney to be given by the Appellant in favour of Mapeley. The powers of attorney are considered in more detail below.

Schedule 9 contained a form of lease to be used when Mapeley leased back to the Appellant freehold or long leasehold properties which had been transferred or assigned by the Appellant to Mapeley. The form of lease contained provisions similar to those in the virtual assignment. For example, it incorporated the occupancy regulations and gave the Appellant options to determine, extend or renew the lease or to purchase the reversion. It also contained schedules I, II and III which were identical to those in the virtual assignment. On the other hand it also contained provisions which were not in the virtual assignment. For example, it contained a provision that if the Appellant failed to pay any rent due or to observe and perform the covenants in the lease then Mapeley could re-enter the premises and terminate the lease. It also contained a provision that the parties could agree that certain statutory provisions should be excluded in relation to the tenancy created by the lease.

The virtual assignment

As mentioned, clause 4 of the Master Agreement provided that if, for any reason, a sale was not completed on the completion date, the Appellant and Mapeley would execute a virtual assignment pending completion of the lawful assignment of that property to Mapeley. The form of the virtual assignment was included as Schedule 5 of the Master Agreement.

On 24 October 2000 the Appellant and Mapeley (called the Purchaser) entered into the virtual assignment. Instead of formal assignments by the Appellant to Mapeley of some leasehold interests Clause 4 of the virtual assignment provided:

"4. The intention of the Virtual Assignment is to pass to the Purchaser all of the economic benefits and burdens of the Leases and Underleases in respect of the Properties, together with the obligation to manage all dealings with the Landlords and Undertenants as if the Properties had been assigned to the Purchaser but without this Virtual Assignment creating, vesting or granting any legal or equitable estate in the Premises to the Purchaser. To this end, any monies from any Undertenants pursuant to any Underleases, together with all proceeds of any disposal of the Leases or for the surrender of any Underleases, shall belong to the Purchaser."

Instead of formal lease-backs from Mapeley to the Appellant Clause 2 of the virtual assignment provided:

"2. Abbey National shall be entitled to occupy all or any part of the Premises (subject to the Master Agreement) for the Term, and in consideration of the agreements on the part of the Purchaser contained in this Virtual Assignment, shall pay to the Purchaser the Principal Fee as described in the Particulars, subject to review in accordance with the Occupancy Regulations. Abbey National shall be deemed to have the benefit of the rights set out in Schedule I, and shall be subject to the rights set out in Schedule II, in the same way as if such rights had been granted. Abbey National's occupation shall be subject to the matters set out in Schedule III."

The particulars consisted of a schedule of all the properties the subject of the virtual assignment and, in respect of each property, a different principal fee was stated.

Clause 3 of the virtual assignment incorporated the occupancy regulations from the Master Agreement. Clause 5 provided that Mapeley would pay to the landlords all the rents on the relevant dates and would observe all the covenants in the leases. Under Clause 6 the Appellant appointed Mapeley to be its agent to act on its behalf in all dealings connected with the properties including the payment of rent and service charges, applying for permissions, licences and consents, granting new underleases, and negotiating and completed surrenders or renewals of the leases. Mapeley was to have full discretion in the conduct of negotiations with third parties and the terms of agreements with third parties.

Schedule I of the virtual assignment set out rights granted to the Appellant which included rights normally given to tenants such as rights relating to the common parts of premises; Schedule II set out the rights reserved to Mapeley which included rights normally reserved to a landlord; and Schedule III set out matters to which the virtual assignment was subject which included matters such as the covenants contained or referred to in the documents of title to each property.

A separate form of virtual assignment was used where property was vacant. Such a virtual assignment had a clause containing a statement of intention to pass the economic benefits and burdens to Mapeley but did not give the Appellant any rights of occupation and did not oblige the Appellant to pay any fee to Mapeley.

In a few cases real assignments of leases were made by the Appellant to Mapeley after the virtual assignment.

The powers of attorney

Schedule 6 of the Master Agreement contained forms of powers of attorney to be given by the Appellant in favour of Mapeley. In respect of each of the properties the subject of the virtual assignment the Appellant entered into a power of attorney. Clause 6 of each power of attorney provided that the Appellant irrevocably appointed Mapeley to be its attorney with very wide powers to do all acts and things on behalf of the Appellant and in its name to give proper effect to the provisions of the Master Agreement and of the documents entered into pursuant to the Master Agreement so far as they related to the sale, purchase, and leasing of the properties including the power to execute agreements, deeds, documents and other notices.

The notices to landlords and tenants

On 30 November 2000 the Appellant wrote to its landlords about the disposal of its property portfolio by way of sale and leaseback. The letter which was sent where there had been a virtual assignment read:

"We are writing to reassure you that nothing has changed to affect the landlord and tenant relationship already existing between us in relation to the above property and that any necessary consents required from you to an assignment or an underletting will be requested in the usual way in accordance with the terms of the lease.

However, from 25 December 2000 the day-to-day running and property management of the property will be carried out for us by Mapeley … who has appointed Nelson Bakewell as their managing agent. In particular Mapeley has directed Nelson Bakewell on our behalf to pay the rent due and owing to you from time to time and also Mapeley … has our authority to deal with you direct as our agent on all matters relating to the lease of the property."

This letter gave rise to a number of requests for clarification and in reply Nelson Bakewell wrote in the following way:

"Mapeley … has acquired from Abbey National the benefit of any income stream being produced from the estate. In addition, they now have responsibility for day-to-day running of the estate including the payment of rent due and owing to you from time to time. Mapeley has authority to deal with you direct as agent to Abbey National on all matters relating to the lease of the property. In turn, Mapeley has appointed Nelson Bakewell as their managing agent. "

On 18 December 2000 Nelson Bakewell wrote to each of the Appellant's tenants to say that the new landlord would be Mapeley but that there would be no change in the individuals at Nelson Bakewell dealing with the property. The same letter was sent both to tenants whose lease was formally assigned by the Appellant to Mapeley and also to tenants where there was a virtual assignment from the Appellant to Mapeley.

The implementation of the agreements

The effect of the Master Agreement was that both the risk and the reward of the Appellant's property portfolio passed to Mapeley. Legal title to the properties was transferred to Mapeley where this was possible but, where it was not, the position was governed by the virtual assignment. At the business level Mapeley did not distinguish between properties where legal title had been transferred on the one hand and properties the subject of the virtual assignment on the other.

Thus it was Mapeley who paid the rent to landlords who had granted leases to the Appellant. Where there had been a legal assignment to Mapeley the Appellant paid the indexed rent to Mapeley until the Hold Date for that property. If the Appellant ceased to occupy such a property at the Hold Date there was no longer any liability to pay the indexed rent to Mapeley. Similarly, if the Appellant ceased to occupy any property the subject of a virtual assignment at the Hold Date it no longer had any liability to pay any principal fee to Mapeley but in each case Mapeley continued to pay the rent to the landlord until the expiry of the lease. However, Mapeley could decide how to deal with vacant property (either by under-letting or assignment with the consent of the landlord) using the power of attorney. Mapeley advertised such properties for sale on its own instructions.

Mapeley also managed all dealings not only with landlords but also with tenants. This included negotiating and granting new leases, surrenders and assignments and collecting and keeping rents and assignment premiums. Where under tenants were in default Mapeley took enforcement action using the power of attorney and without recourse to the Appellant. Mapeley also negotiated rent reviews in respect of the leasehold property whether formally assigned or the subject of the virtual assignment. For example, under the virtual assignment the Appellant paid Mapeley a principal fee of £183,468 per annum for a property which it planned to vacate in 2004. Following a rent review the rent payable to the landlord was increased to £311,000 per annum from 24 October 2001. Mapeley paid the increased rent to the landlord and will do so until the lease expires in 2006. Thus in respect of this property Mapeley made a loss. In another property the rent paid by Mapeley to the landlord was less than the indexed rent paid by the Appellant to Mapeley so in respect of that property Mapeley made a profit. In yet another case a rent review was negotiated entirely by Mapeley including the arbitration hearing and High Court proceedings.

Properties in Scotland

We have found the facts which are relevant to properties in England and Wales. A separate Scottish Property Agreement, instead of a virtual assignment, was entered into relating to properties in Scotland. It was not argued that there was any difference in the value added tax treatment of the transactions where the property was situated in Scotland.

The registration of land charges

On 9 May 2002 Mapeley applied to the land charges department of HM Land Registry for the registration of a charge dated 24 October 2000 between Mapeley and the Appellant as a Class C (iv) land charge against one of the properties the subject of the virtual assignment. We were informed that similar land charges had also been registered against the other properties the subject of the virtual assignment.

Reasons for decision

We consider separately each of the issues for determination in the appeal.

Issue (1) – Did Mapeley make exempt supplies to the Appellant?

The first issue is whether under the virtual assignment the supply by Mapeley to the Appellant was an exempt supply to the Appellant of the leasing or letting of immovable property within the meaning of Article 13B(b) (as argued by the Appellant) or whether the principal fee was paid for standard-rated supplies of agency and property management services (as argued by Customs and Excise).

It was agreed (1) that the supplies by the Appellant to Mapeley of the freehold properties and of the long leasehold properties where the consent of the landlord to assign was not required, and (2) that the supplies of the leases back of such properties from Mapeley to the Appellant, were exempt supplies falling within Item 1 of Group 1 of Schedule 9 of the 1994 Act unless there had been an election to waive exemption. The dispute concerned supplies by Mapeley to the Appellant in respect of properties the subject of the virtual assignment where there had been no election to waive exemption.

This issue concerns the meaning of the words "the leasing or letting of immovable property" which appear in Article 13B(b) of the Sixth Directive. We first very briefly consider the position under our national law; we then refer to the judgments of the Court of Justice cited to us to see what principles of interpretation the Court has established; and finally we apply those principles to the facts of the present appeal.

The position under national law

Following Warmington v Miller [1973] 1 QB 877 at 886 Mapeley could not obtain specific performance from the Appellant of the legal assignment of the leases the subject of the virtual assignment because that would necessitate a breach by the Appellant of its covenants with its landlords and would terminate the leases. In Central Trust and Safe Deposit Company v Snider [1916] 1 AC 266 at 272 it was held that the interest of a purchaser was commensurate only with what would be decreed by a court of equity in specifically performing the contract. Rosen v Trustees of Camden Charities [2002] 2 All ER 399 at 405 para 22 to 407 para 30 established the principle that a person who enters into an agreement for a lease acquires an equitable interest in the land which would be protected by injunctive relief but he does not become a tenant either in law or in equity because he could not have obtained specific performance of the legal grant of the lease at the relevant time. We were also referred to Chronopolous v Caltex Oil (Australia) Pty Limited {1982} 70 FLR 8 for the principle that there was no privity of contract or estate between the Appellant's landlords and Mapeley and so there could be no supply of land from the former to the latter nor from the latter to the former. Thus, as a result of these authorities, after the virtual assignment the Appellant remained the tenant under the leases granted to the Appellant.

These principles were accepted by the Appellant who also accepted that it was not possible to ignore the rights and obligations of the landlords and the Appellant under the leases to the Appellant. However, the Appellant argued that the rights and interests in the land enjoyed by the Appellant had been modified by its personal contract with Mapeley; that although the Appellant retained bare legal rights and obligations it was not, as a matter of reality, entitled to those rights nor subject to those burdens; and that the position under English land law was not relevant in the light of the principles established by the Court of Justice. We therefore now turn to consider those principles.

The principles established by the Court of Justice

The Court of Justice has had occasion to consider the meaning of Article 13B(b) on a number of occasions. In 1994 in Lubbock Fine v Customs and Excise Commissioners ...Case C-63/92) [1994] STC 101 the Court decided that the surrender of a lease for a consideration was an exempt supply where the grant of the lease had been an exempt supply. The Advocate General at 117 paragraph 39 said that "a letting is a contract by which the owner transfers in return for rent certain rights in his property, such as the right of enjoyment of the property, whatever the nuances of national law on this point". A letting for the purposes of Community law included a lease and a licence.

EC Commission v United Kingdom (Case C-359/97) [2000] STC 777 concerned the question as to whether the United Kingdom had failed to fulfil its obligations under the Sixth Directive as it did not levy value added tax on road tolls. One of the arguments of the United Kingdom was that road tolls were exempt under Article 13B(b). At 778 paragraphs 75 and 76 the Advocate General said that the exemptions were to be interpreted narrowly and that the term "leasing of immovable property" must be defined according to its usual meaning and not every contract which had some characteristics of a lease was automatically covered by the term; the requirement was that the characteristics of a lease should predominate in the contract. At 805 paragraphs 63 to 68 the Court of Justice held that the exemptions in Article 13 had their own independent meaning in Community law and had to be given a Community definition. The meaning of "the leasing or letting of immovable property" was wider in some respects than that enshrined in various national laws because the exclusions from the exemption (for example, a contract for hotel accommodation) would not be considered in some national laws to be a contract to let. That aside, the term had to be construed strictly and could not be considered to cover contracts where the parties had not agreed on any duration for the right of enjoyment of the immovable property, which was an essential element of the contract to let.

One year later in Customs and Excise Commissioners v Mirror Group Plc (Case C-409/98) [2001] STC 1453 at 1469 paragraph 31 the Court of Justice held that the letting of immovable property involved the landlord assigning to the tenant in return for rent, and for an agreed period, the right to occupy his property and to exclude other persons from it.

In Stichting "Goed Wonen" v Staatsecretaris van Financiën (Case C-326/99) (decided on 24 October 2001) [2003] STC 1137 one of the issues was whether a national provision could apply the exemption for the leasing or letting of immovable property to the grant of a usufructuary right over land for a limited period of time and for payment. (Under Netherlands national law a usufrutuary right was an exclusive right in rem which gave the holder the right to use the property of another and to take the fruits of that property.) In paragraph 60 of his Opinion (at 1147h) the Advocate General referred to a lease as a grant to the tenant of an exclusive right (similar to ownership) to occupy or take the profits from land or buildings for a fixed period of time. It did not matter that the right granted was a right in rem whereas a leasing or letting was usually a personal rental contract. At paragraph 80 he went on to say that a functional approach guaranteed the equal treatment of taxable persons who in economic terms performed equivalent transactions and such an approach also facilitated the uniform application of the exemptions throughout the Community. Having referred to the definition proposed in Lubbock Fine he went on, in paragraph 84, to propose a more specific interpretation of the phrase "a leasing or letting of immovable property" as "agreements whereby one party grants the other the right to occupy a defined immovable property as his own and to use or even to take profits from that property for an agreed (definite or indefinite) duration in exchange for remuneration linked to that duration". The Court of Justice held, in paragraph 55, that the exemption could apply because the fundamental characteristic of the transaction was the conferring on the person concerned for an agreed period and for payment the right to occupy property as if that person were the owner and to exclude any other person from enjoyment of such a right. In paragraph 58 the Court said that economically a usufructuary right on the one hand and leasing and letting on the other had these essential common characteristics. In paragraph 59 the Court concluded that a grant, for an agreed period and for payment, of a right in rem entitling the holder to use immovable property was to be treated as the leasing or letting of immovable property.

Next, in Maierhofer v Finanzamt (Case C-315/00) [2003] STC 564 (decided on 16 January 2003) the issue was whether the lease of a pre-fabricated building, which could be dismantled or easily moved, built partly on land owned by the lessor and partly on land owned by another person was the leasing or letting of immovable property and the Court of Justice held that it was. At paragraphs 25 to 28 the Court repeated the principles that the exemptions in the Sixth Directive had their own independent meaning in Community law; that the meaning could not be determined by the interpretation given by the national law of a member state; and that it was appropriate to consider the context in which the provision occurred. At paragraph 39 the Court held that Article 13B(b) defined exempt transactions by reference to the nature of the transactions effected. In order to determine whether a transaction comprised a letting account must be taken of its essential features irrespective of the way in which it might be artificially presented.

Finally, in Wolfgang Seeling v Finanzamt Starnberg (decided on 8 May 2003) (Case C-269/00) [2003] ECR I-04101 the issue was whether the private use by a taxable person of part of a building which was an asset of his business could be an exempt supply of leasing or letting. At paragraphs 49 and 51 the Court of Justice held that it could not because the leasing of immovable property for the purposes of Article 13(b) involved the landlord of property assigning to the tenant, in return for rent and for an agreed period, the right to occupy his property and to exclude other persons from it.

From these authorities we derive a number of principles. The exemptions in Article 13 have their own independent meaning in Community law and must be given a Community definition. The meaning of "the leasing or letting of immovable property" is wider in some respects than the meaning in some national laws because the exclusions from the exemption (for example, a contract for hotel accommodation) would not be considered in some national laws to be a contract to let That aside, the term has to be construed strictly. A lease or letting is a contract by which the owner transfers in return for rent certain rights in his property, such as the right of enjoyment of the property, whatever the nuances of national law. The right of enjoyment may either be a right of occupation or the right to underlet or otherwise take profits from the property. A leasing or letting must be of an agreed duration and must be in exchange for remuneration linked to that duration. A letting in Community law includes a lease and a licence and also a grant of a right in rem. Not every contract which has some characteristics of a lease is automatically covered by the term; the requirement is that the characteristics of a lease should predominate in the contract. A functional approach should be adopted as this guarantees the equal treatment of taxable persons who in economic terms perform equivalent transactions and such an approach also facilitates the uniform application of the exemptions throughout the Community.

The legal principles applied to the facts

We now turn to apply those principles to the facts of the present appeal and we remind ourselves that what we have to decide is whether the supply to the Appellant by Mapeley under the virtual assignment was the leasing or letting of immovable property.

We begin by identifying what rights were supplied to the Appellant by Mapeley under the virtual assignment. Clause 4 describes what the Appellant supplied to Mapeley. This was the economic benefits and burdens of the leases but without passing any legal or equitable estate. It is interesting that what was not transferred to Mapeley was either the right to occupy the properties or the right to take profits from them through assignment or under letting them. The reason was, of course, that the assignment of these rights required the consent of the landlord which had not been obtained. Clause 2 of the virtual assignment purports to describe what Mapeley supplied to the Appellant, namely entitlement to occupation in return for the principal fee. This was no doubt meant to mirror the provisions in the lease backs of the freehold and leasehold properties which were legally transferred. However, it ignores that fact that the Appellant already had the right to occupy the properties, and to take profits from them by way of assignment or under-letting, under the terms of its leases. It is also relevant that, in the absence of the landlord's consent, no other person than the Appellant, and certainly not Mapeley, had the right to occupy the property nor could the Appellant assign to Mapeley the right to take profits from the property by way of assignment or under letting.

It seems to us, therefore, that whatever rights were supplied by Mapeley to the Appellant under the virtual assignment they did not include the right of occupation nor the right to assign or underlet or take profits from the property. The Appellant already had these rights; it was prohibited from transferring them to Mapeley; and so Mapeley could not transfer them back to the Appellant. The transaction thus lacks two of the most important elements of a lease or letting (the right to occupy or the right to take profits from the property). In addition, Mapeley was not the owner of the property and so the transaction between Mapeley and the Appellant did not meet a third requirement of a lease or letting which is that the owner should transfer rights in his property.

We accept that the rights given by Mapeley to the Appellant do have some of the characteristics of a lease. They were of an agreed duration and in exchange for remuneration linked to that duration. Although there was no grant of a right in rem, or of a legal or equitable estate under national law, that is not necessary in Community law. We were attracted by the argument that we should adopt a functional approach and give equal treatment to transactions which in economic terms are equivalent transactions. Under such an argument the same position should apply as if the leasehold interests had been legally assigned by the Appellant to Mapeley and then followed by a lease back from Mapeley to the Appellant. This argument is supported by the fact that from a business point of view the parties did not distinguish between properties where there had been a formal assignment to Mapeley and properties where there had been a virtual assignment. However, such an argument is contrary to two of the principles established by the Court of Justice. The first is that not every contract which has some characteristics of a lease is covered by that term and the requirement is that the characteristics of a lease should predominate in the contract. In our view the major requirements of the grant by an owner of property of a right of occupation or a right to enjoy the profits of the property are lacking in what was supplied by Mapeley to the Appellant under the virtual assignment and so the characteristics of a lease do not predominate in the contract. Secondly, the exemptions must be narrowly construed and the argument would widen them considerably.

We were also attracted by the argument that we should ask what the principal fee under the virtual assignment was paid for and it was suggested that the answer was that it was paid for the entitlement to occupy the properties. This argument was supported by the fact that the Appellant had no obligation to pay a principal fee to Mapeley under the virtual assignment if it did not occupy a property and so, the argument runs, the payments must have been for the rights of occupation. However, we cannot agree with these arguments because in our view Mapeley did not grant to the Appellant any rights of occupation.

The single answer to these two attractive arguments is that the Appellant's right of occupation, and the right to enjoy the properties by assignment or underletting, derived from the lease with its landlord and not from the virtual assignment. The virtual assignment was a personal collateral agreement between the Appellant and Mapeley which did not grant rights of occupation but which did regulate how certain rights were to be exercised but only as between the Appellant and Mapeley. The fact that the Appellant agreed with Mapeley that the Appellant would occupy the premises subject to the occupancy regulations made no difference. The regulation of the right to occupy is not the same as the grant of a right to occupy. The right to occupy was given by the lease and the occupancy regulations were merely an agreement as to how the rights of occupation should be exercised as between the Appellant and Mapeley.

We are confirmed in our view by a number of other considerations. Under the virtual assignment Mapeley had no rights to dispose of the leases; only the Appellant could assign or underlet them with the consent of the landlords; all Mapeley could do was to act as the Appellant's agent. Also, if a renewal or extension of a lease were required the only person who could apply to the landlord for such renewal or extension was the Appellant and if Mapeley made such an application it was as agent for the Appellant. After the virtual assignment the Appellant and not Mapeley remained liable for payments of rent to the landlord. Although as between Mapeley and the Appellant Mapeley agreed that it would pay the rent that did not absolve the Appellant from its liability and if, for example, Mapeley had become insolvent, the Appellant's liability would remain. Also, when under the virtual assignment the Appellant vacated a property on a Hold Date which was before the termination of the lease, the Appellant remained liable to the landlord for the rent although as between the Appellant and Mapeley that obligation was assumed by Mapeley. Further, Mapeley had no right to occupy the vacated property until the consent of the landlord had been obtained. Again, as far as rent reviews were concerned, only the Appellant could request such a review although Mapeley could act for the Appellant in negotiations. The letter to landlords of 30 November 2000, and the subsequent letter of clarification from Nelson Bakewell, say it all; what Mapeley acquired from the Appellant was an income stream but not rights under the leases and so Mapeley could not make a supply of leasing or letting to the Appellant.

We therefore conclude that under the virtual assignment the supply by Mapeley to the Appellant was not an exempt supply of the leasing or letting of immovable property within the meaning of Article 13B(b).

That conclusion only deals with the first part of the first issue. The second part is whether the principal fee was paid in return for agency and property management services. In analysing what the payment by the Appellant to Mapeley was for we have concluded that it was not a payment for a leasing or letting of immovable property. However, in our view neither was the whole of the payment for property management and agency services. Although Mapeley did have the responsibility to manage the property that applied to property the subject of the legal assignments as well as to the virtual assignments. The rents due under the leases back where there had been a legal transfer of title could not be charges for agency and property management services and the same principle should apply to the principal fees under the virtual assignment.

Clause 2 of the virtual assignment provided that the principal fee was to be paid by the Appellant to Mapeley "in consideration of the agreements on the part of [Mapeley] contained in this virtual assignment". These agreements included the agreement under clause 5 of the virtual assignment under which Mapeley undertook to discharge the Appellant's obligations to the landlords for the rents. (Where there had been a legal assignment of a lease Mapeley became liable instead of the Appellant as a result of that assignment to pay the rent to the landlord). Under the virtual assignment the payments of rent by Mapeley to the landlords were in connection with exempt supplies by the landlords to the Appellant although paid by Mapeley for the Appellant.. In our view, therefore, the principal fees paid by the Appellant to Mapeley were in part payments to Mapeley to be used by Mapeley primarily in discharging the Appellant's obligations to the landlords, the remainder being for agency and property management services.

Our conclusion on the first issue for determination in the appeal is that under the virtual assignment the supply by Mapeley to the Appellant was not an exempt supply of the leasing or letting of immovable property within the meaning of Article 13B(b) and that the principal fee paid by the Appellant to Mapeley was partly for the payments of rents due to landlords by the Appellant the rest being for standard-rated supplies of agency and property management services.

Issue (2) – Did the rents of the under leases accrue to Mapeley?

The second issue for determination in the appeal is whether under the virtual assignment the rents of the under leases "accrued" to Mapeley within the meaning of paragraph 8(1) of Schedule 10 so that Mapeley was to be treated as the person who made the exempt supplies to the under tenants (as argued by the Appellant) or whether the rents of the under leases belonged to the Appellant and when paid to Mapeley constituted consideration paid by the Appellant for standard-rated supplies of agency and property management services made to the Appellant by Mapeley.(as argued by Customs and Excise).The context of this issue is that before and after the virtual assignment the Appellant underlet some of the properties and by the virtual assignment assigned to Mapeley the right to receive the rents. The rents were thus paid to Mapeley by the under-tenants.

In considering this issue we start with the words of the legislation. Paragraph 8(1) of Schedule 10 provides that where the benefit of a rent (which is the consideration for the grant of an interest in, right over or licence to occupy land) "accrues" to a person who is not the grantor that person is treated as the grantor. The normal and natural meaning of the word "accrue" is a natural growth or increment or an accession or an advantage (the New Shorter Oxford English Dictionary). The word does not appear to require a mode of acquisition recognised by law and, in our view, should not therefore be construed strictly. Under paragraph 4 of the virtual assignment it was agreed that any monies from any under tenants "belonged" to Mapeley. Further, schedule 2 paragraph 4 of the Master Agreement provided that the Appellant held the benefit of the under leases in trust for Mapeley. Giving the word "accrues" its normal and natural meaning we are of the view that the rents of the under leases did "accrue" to Mapeley.

In this connection the time of supply rules are relevant. Regulation 85 of the Value Added Tax Regulations 1995 (SI 1995 No. 2518) provides that where the grant of a lease is a supply of goods and the consideration is payable periodically the goods are to be treated as separately and successively supplied each time that a part of the consideration is received by the supplier (or each time that the supplier issues a tax invoice if earlier). This means that each payment of rent is for a separate supply. Paragraph 4 of Schedule 4 of the 1994 Act provides that the grant, assignment or surrender of a major interest in land is a supply of goods. Major interest in land is defined in section 96(1) of the 1994 Act as a fee simple or a tenancy for a term certain exceeding twenty-one years. Other leases are supplies of services and Regulation 90 provides that where services are supplied for a consideration which is determined or payable periodically they are to be treated as separately and successively supplied each time that a payment is received by the supplier (or each time that the supplier issues a tax invoice if earlier). Thus whether the under leases in this appeal are supplies of goods or supplies of services the time of supply is the date on which each payment is rent is received. Thus it is possible for each payment of rent to be treated separately. For that reason it is sensible to provide (as does paragraph 8(1) of Schedule 10)) that each person who receives the consideration for the exempt supply of the under-letting should be responsible for the tax (if any).

For Customs and Excise Mr Parker argued that paragraph 8(1) of Schedule 10 was addressed to the situation where, under the terms of a grant, the grantee was directed to make a payment to someone other than the grantor. He went on to argue that the Appellant's under tenants were not obliged to make any payments to Mapeley until the lease had been formally assigned and until then Mapeley acted as a collecting agent for the Appellant. However this interpretation requires the reading into paragraph 8(1) of Schedule 10 of words which are not there and we do not consider that paragraph 8(1) of Schedule 10 is limited in that way.

We also do not agree that, as a matter of economic reality, the rents when paid to Mapeley constituted consideration paid by the Appellant for standard-rated supplies of agency and property management services made by Mapeley to the Appellant. That is not what the rents were paid for. They were paid to Mapeley as part of the economic transaction which was the whole property transaction consisting both of the Master Agreement and the virtual assignment. Part of the total agreement as between Mapeley and the Appellant was that Mapeley should receive rents due to the Appellant and that Mapeley had an obligation to pay any rents due from the Appellant to the landlords (as agent for the Appellant). Thus the payment of the rents of the under leases to Mapeley was not consideration paid by the Appellant for standard-rated supplies of agency and property management services.

As the Appellant is successful on this issue we do not have to consider its alternative argument in detail. The alternative argument was that if the payment of rent by the under tenant was to the Appellant then it had to be regarded as in respect of a supply made by the Appellant. Mapeley's entitlement to the rent would then be regarded as consideration paid by the Appellant to Mapeley under the terms of the virtual assignment and such consideration should be treated in the same way as the principal fee namely as payments for the leasing or letting of immovable property. However, as the alternative argument assumes that the supplies by Mapeley to the Appellant under the virtual assignment were exempt supplies of the leasing or letting of immovable property, and as we have already found that they were not, we are not persuaded by the alternative argument.

We conclude that under the virtual assignment the rents of the under leases "accrued" to Mapeley within the meaning of paragraph 8(1) of Schedule 10 so that Mapeley was to be treated as the person who made the exempt supplies to the under tenants; when the rents of the under leases were paid to Mapeley they did not constitute consideration paid by the Appellant for standard-rated supplies of agency and property management services.

Decision

Our decisions on the issues for determination in the appeal are:

(1) that under the virtual assignment the supply by Mapeley to the Appellant was not an exempt supply to the Appellant of the leasing or letting of immovable property within the meaning of Article 13B(b) and that the principal fee paid by the Appellant to Mapeley was partly to reimburse Mapeley for paying the rent due from the Appellant to its landlords only the remainder being for standard-rated supplies of agency and property management services; and

(2) that under the virtual assignment the rents of the under leases "accrued" to Mapeley within the meaning of paragraph 8(1) of Schedule 10 so that Mapeley was to be treated as the person who made the exempt supplies to the under tenants; when the rents of the under leases were paid to Mapeley they did not constitute consideration paid by the Appellant for standard-rated supplies of agency and property management services.

The appeal is therefore allowed in part.

Costs

Both parties applied for their costs if they were successful in the appeal. However, neither party has been completely successful. If costs cannot be agreed then we direct that either party may make an application for costs.

DR NUALA BRICE

CHAIRMAN

RELEASE DATE:21/6/2004

LON/2003/0303

06.04