On 16 November, HMRC announced that a grant of a lease subject to one or more underleases could be a transfer of a letting business as a going concern (TOGC) for VAT purposes. This was a complete about turn on its previous position. HMRC now accepts that the grant of a lease over a let property is capable of being a TOGC provided that the lessor (seller) retains only a small reversionary interest of no more than 1% of the value of the property. Clearly this is good news, but its full effect may prove to be significant.
Impetus for change
In Robinson Family Ltd v Commissioners for HM Revenue and Customs [2012] UKFTT 360 (TC); [2012] PLSCS 159, owing to restrictions on alienation in its head lease, Robinson Family Ltd (RFL) sold its letting business by means of the grant of a sublease. The sublease was granted for a premium (the sale price) and expired only three days before the head lease, meaning that RFL retained a small reversionary interest in the land. HMRC denied RFL TOGC treatment on the basis that the grant of the sublease amounted to the creation of a new asset, rather than the transfer of an existing one, and so could not be a TOGC.
The First-Tier Tribunal found against HMRC, holding that RFL had in substance transferred its letting business as a going concern even though the legal form of such transfer was a grant of a sublease. The basis for this decision was that the letting business was in substance unchanged by the grant of the sublease; the legal nature of the assets constituting a business was subordinate to the analysis of the substance of that business. The letting business existed prior to the grant of the sublease (carried on by RFL) and continued to exist in substantially the same form after the sublease was granted (but now carried on by the sublessee).
HMRC’s response: grants, surrenders and SDLT
HMRC will not appeal this decision. It accepts that the transfer of a letting business by means of the grant of a lease may amount to a TOGC; the fact that the lessor retains a small reversionary interest in the property transferred does not preclude the transaction from being a TOGC for VAT purposes, provided that the substance of the transaction is not altered. However, HMRC has imposed a maximum size on the value of the reversionary interest that the lessor may retain before it will regard the substance of the transaction as a TOGC: the value of the reversionary interest may not exceed 1% of the value of the property immediately before the transfer (disregarding any mortgage or charge).
HMRC is also reviewing its policy on whether surrenders of interests in land can result in TOGCs. It has yet to make a firm announcement in this regard.
Given that where a lease is granted for a premium plus VAT, SDLT is due on both the premium and the VAT, HMRC acknowledges there is a question to be considered as to whether any SDLT paid on VAT can now be reclaimed. HMRC is considering the point and has stated that it will provide further guidance on it.
What does it mean in practice?
The implication for completed transactions of lease grants is that while VAT may be refundable, it is likely that any lessee will have been able to recover the VAT incurred on the purchase of the business in the course of its everyday running. Lessees that have been unable to recover the VAT charged by lessors may find that the transfer was not eligible to be treated as a TOGC if they have not continued to operate the lessor’s letting business.
Taxpayers that have paid irrecoverable VAT in these circumstances should consider their options and undertake due diligence on the lease contract to ascertain what rights of recovery exist.
As regards SDLT paid on VAT, the strict legal position here is complicated by the fact that, under the primary SDLT law, any SDLT that has been overpaid by mistake but based on a calculation that was in accordance with practice generally prevailing at the time is not refundable.
However, common law claims for refunds are likely to be available to taxpayers, so it is hoped that HMRC will take a pragmatic line on this point and provide for a sensible procedure for taxpayers to claim refunds of overpaid SDLT without having to resort to potentially time-consuming and expensive legal remedies. In any event, taxpayers who believe they should be entitled to a refund would be well advised to make their claims for refunds as soon as possible.
Looking forward, it is clear that transfers of letting businesses by means of the grant of a lease are capable of being regarded as TOGCs, provided that the other TOGC conditions are satisfied and that the value of any retained interest does not exceed 1% of the value of the property immediately prior to the transaction in question. However, even if a larger percentage is being retained (say a 5% or 10% rent share), taxpayers should not accept that the lease grant cannot be a TOGC simply because the percentage income retained is higher than the 1% referred to in HMRC’s new guidance.
As regards occupational tenants, the grant of the lease in these circumstances will still place the lessee in the same position after the lease has been granted as the lessor was in before it. The lessee will assume from the lessor the rental income derived from the occupational tenants, albeit that the lessee will have created its own obligation to pay to the lessor an amount equal to 5% or 10% of such rental income from the occupational tenant.
Buyers contemplating future lease surrenders should carefully review the proposed terms and perhaps consider including wording that allows possible future treatment as a TOGC depending on the facts of the transaction, based on the same analysis as for grants of leases, explained above. Of course, this is only relevant where there is an existing property rental business, which is effectively being transferred by means of the surrender.
Neil Warriner is a partner at Herbert Smith Freehills LLP