Immovable property — University authorising construction works — Reversionary lease — Tax planning — Grant of VAT-exempt 999-year lease to non-VAT registered subsidiary at full premium and transfer of freehold reversion at nominal charge to university — Appellant cancelling VAT registration — Whether final adjustment requiring VAT apportionment according to respective values of lease and transfer — Preliminary ruling given
A university arranged for the construction of a building. Following its completion, the university sold the freehold of the property to the appellant company as a VAT standard-rated supply of a new commercial building for £6.5m plus VAT. In return, the appellant elected to waive exemption in respect of the property and granted a short lease to the university, which was thereby enabled to reclaim VAT on the construction costs, although it became liable for VAT on the rent paid.
The appellant subsequently granted a 999-year lease to an unregistered subsidiary of the university at a premium of £6.4m, an exempt transaction for VAT purposes. This was followed by the taxable transfer of the freehold reversion to the university for £1,000 plus VAT. The appellant subsequently cancelled its VAT registration. A question then arose as to how to apply the rules of adjustment of the deduction of input tax paid on the appellant’s acquisition of the building, under regulation 115(3) of the Value Added Tax Regulations 1995 (SI 1995/2518).
The respondent Commissioners considered that regulation 115(3), implementing article 20(3) of Council Directive 77/388 (the Sixth Directive), required an apportionment between the grant of the exempt 999-year lease and the taxable transfer of the freehold reversion in proportion to their respective values, resulting in a VAT liability of £796,090. The appellant argued that it had disposed of its entire interest in the building by the transfer of the freehold reversion alone, giving a VAT liability of no more than £943.93.
At first instance, the VAT tribunal concluded that the reversionary lease and the transfer had been pre-ordained since the transfer was certain to take place once the reversionary lease had been granted. Therefore, the proper application of regulation 115(3) required an apportionment between them. The appellant appealed to the High Court. The court made a reference to the European Court of Justice for a preliminary ruling on the proper application of article 20(3), which set out a special system of adjustment with regard to immovable property.
Held: The preliminary ruling was given in favour of the respondents.
Because the grant of the lease and the transfer of the freehold reversion were inextricably linked and constituted supplies that were, respectively, exempt and taxable for VAT purposes, account had to be taken of the two supplies in proportion to their respective values for the purposes of the adjustment required by article 20(3).
The system of deductions and adjustments provided for in articles 17 to 20 of the Sixth Directive was intended to establish a close and direct relationship between the right to deduct input VAT and the use of the goods and services concerned for taxable transactions. In the specific circumstances of this case, taking into account each of the two supplies proportionately was most likely satisfactorily to attain that objective.
Roderick Cordara QC and Paul Key (instructed by Landwell Solicitors) appeared for the appellant; Karim Manji, acting as agent, and Nigel Pleming QC (instructed by the Treasury Solicitor) appeared for the respondents; Richard Lyal, acting as agent, appeared for the EC Commission, an interested party.
Eileen O’Grady, barrister
