VAT – TOGC – HMRC – good news
You may be able to alter your VAT return and be repaid overcharged SDLT
It is not very often that these abbreviations and words go together, but over the last 2 years we have seen the courts and HMRC taking a much more pragmatic approach to what may constitute a TOGC (a transfer of going concern) for VAT purposes. Recent case law indicates that "one must look to the substance of the transaction rather than its form".
TOGCs minimise cash flow because the acquirer does not have to fund the initial payment of the VAT (even if this is fully recoverable at a later stage) and will reduce the SDLT (because SDLT is usually payable on the price plus the VAT charge). Acquirers are thus keen to ensure that the relevant supply is treated as a TOGC.
HMRC (unlike the EC Directive upon which our legislation is based and the ECJ which interprets this legislation) have until now taken a very strict and narrow-minded view as to what may or may not constitute a TOGC. In the context of property rental businesses, HMRC have previously stated that the following could not be TOGCs:
- The grant of a long lease which would be subject to third party subleases.
- The surrender of a lease subject to third party leases (because typically the surrendered lease would merge with the landlord's existing interest and thus the landlord would not be using the same asset, i.e. the surrendered lease, to carry on the property rental business).
Grant of a lease
In respect of the grant of a lease, following the case of Robinson Family Limited , HMRC has now confirmed in the Revenue and Customs Brief 30/12 that the grant of a long lease where the residual value in the reversionary interest retained by the grantor is nominal (i.e. less than 1%) may, subject to meeting various other conditions, be treated as a TOGC.
HMRC gave the following example:
A Ltd owned the freehold of a building valued at £1m which A Ltd rents out commercially. A Ltd sells that property rental business by granting to B Ltd a 999 year lease under which A Ltd is entitled to receive a ground rent of £100 each year. The value of that right, together with any and all other rights retained by A Ltd, is £2,000. Provided all the normal conditions are satisfied, the transaction will be a TOGC, because HMRC will regard the 0.2 per cent interest retained as too small to disturb the substance of the transaction.
It should be noted that the above example need not be followed slavishly. Subject to obtaining a valuation of the residual reversionary interest to be held by the grantor, the following scenario may also qualify as a TOGC (subject to meeting all other usual conditions of course):
C Ltd has a 250 year lease less 3 days at a peppercorn rent from the 31 January 2007. C Ltd grants a lease to D Ltd for a term expiring on 24 January 2257 (i.e. the selling landlord's lease term less 4 days).
Furthermore, HMRC have confirmed in a new Revenue & Customs Brief 27/14 ("RCB 27/14") that these principles also apply to a part of a building and have given us the following example:
A Ltd owns the freehold of a four-storey building, valued at £4m, which A Ltd rents out commercially. The freehold in each floor is worth £1m. A Ltd sells its property rental business in one of the floors by granting to B Ltd a 999 year lease of that floor, under which A Ltd is entitled to receive a ground rent of £100 each year. The value of that right, together with any and all other rights retained by A Ltd in that floor, is £2,000.
A Ltd has retained 0.2 per cent of the value of its interest in the one floor, and 75.2 per cent of the value of its interest in the building as a whole. The 1 per cent figure mentioned in Revenue & Customs Brief 30/12 is to be considered in relation to the one floor alone. Provided all the normal conditions are satisfied, the transaction will be a TOGC, because HMRC will regard the 0.2 per cent interest retained as too small to disturb the substance of the transaction.
In RCB 27/14, HMRC have further announced that these principles apply not only in the context of property rental business but also where e.g. a retailer disposes of its retailing business by way of the grant of a lease.
Surrender of a lease
In respect of the surrender of a lease, HMRC now accept (see RCB 27/14) that where a lease is surrendered subject to one or more sub-tenancies, or where a retailer sells its retailing business to its landlord, this may also be a TOGC (subject to meeting the normal rules). These new principles apply whether or not the landlord's interest is held via one or more trustees.
If a developer who is constructing residential buildings sells (whether by way of a disposal of the freehold or the grant of a long lease) part way through his development and he is the 'person constructing' a qualifying building, then that may be a zero rated supply. Further, the buyer of the site inherits this converted 'person constructing' status and may generally zero-rate his supplies (e.g. the grant of long leases) to the eventual homeowners. This position has not changed.
Previously if a developer had completed his residential/charitable development and sold the site as a TOGC, then HMRC have stated that the buyer did not inherit 'person constructing' status. In RCB 27/14 HMRC have opined that, on a TOGC of a qualifying residential/charitable development, the buyer will inherit 'person constructing' status and is capable of making a zero-rated first major interest grant in that building or part of it, so long as:
- a zero rated grant has not already been made of the completed building or relevant part by a previous owner (for this purpose, HMRC consider that the grant that gives rise to the TOGC should be disregarded);
- the person acquiring the building as a TOGC would suffer an unfair VAT disadvantage if its first major interest grants were treated as exempt (e.g. an adjustment under the Capital Goods Scheme); and
- the buyer would not obtain an unfair VAT advantage by being in a position to make zero-rated supplies (e.g. by recovering input tax on a refurbishment of an existing building).
These principles also apply in respect of 'person converting' status (for buildings converted from non-residential use) and 'person substantially reconstructing' status (for substantially reconstructed listed buildings).
Review your recent contracts and consider if you have been over-charged VAT and/or SDLT.