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Jan

VAT “Abuse”: Artificial Supply Splitting PUBLISHED IN real estate and property

“Abuse” is a technical term in the field of VAT. It denotes a case where a taxpayer has adopted a business structure primarily in order to save VAT, and where that structure is essentially contrived, is apparently un-commercial, and thus results in the frustration of the clear purposes of the VAT Directive. Where a court holds that an “abuse” has occurred, then it needs to consider what the result would have been had the artificial aspects of the structure not been introduced, or, put another way, if it had been structured on a simple commercial basis. That then determines the amount of VAT that needs to be accounted for.

 

HMRC has done well out of this principle where it has challenged schemes involving tortuous supply chains leading to a partly exempt business, and where the result has been the removal of VAT costs to that business. But its attempts to push the principle ever wider, into something more like a GAAR, have met with less success of late. I wrote a blog on 22 December 2010 to report the ECJ’s decision against HMRC both in a leasing structure case and one involving a benefit arising from VAT rule inconsistencies between two EU member states. Now we have an important decision of the Upper Tribunal concerning allegations by HMRC of abusive supply-splitting within the property development industry.
 
The case, Lower Mill, involves a company selling plots of land which had already gained planning consent for “holiday” property development. The purchaser was then obliged to construct the relevant property. Whilst he could appoint a builder of his choice, he usually appointed the recommended contractor for the site, which happened to be a company that was owned by the owner of Lower Mill. 
 
The importance of this is that, whereas the plot supply is subject to VAT (at least in the format chosen by Lower Mill), the construction supply is zero rated, so a large part of the overall cost to the purchaser does not suffer VAT. Contrast this with the position where one company fully develops the property and sells it. That transaction in holiday accommodation would have been subject to VAT on the full price. It follows that the “splitting” was VAT efficient. It follows also that it is sanctioned clearly in the UK VAT legislation which is unambiguous in allowing the zero rate to cover the construction of a holiday home.
 
HMRC decided that the exploitation of this “loophole” was an abuse against the VAT system. This is curious, because anyone who owns land, obtains permission for a holiday development for himself, and then hires a building contractor, can expect not to be charged VAT. So why would replicating that effect be an abuse? The only reason could be that such a comparison is irrelevant. The said advantage for a self builder just happens to exist. Attempts by VAT-avoiders to shuffle sideways to enjoy the same fiscal benefit, by replicating that situation in their commercial structures is, in HMRC’s view, a wholly different thing.
 
But, thinking more laterally still, if the land vendor and the construction company had been unrelated, there could not have been a motive for splitting the supply, because two unrelated companies would not collude in such a way. They would both be making the supplies they wanted to make, and those would happen to generate less VAT cost. So, again, how is that “fair” to the holiday developer, and why should anyone mind if he sought to replicate that using his own separate companies?
 
The answer to that question would be in the level of contrivance involved in performing the split. If HMRC could show that the above mentioned separate supplies by two unrelated parties to one consumer simply would not arise in the real commercial world, and that the only circumstances where you would find it would be where VAT was being avoided, then perhaps they could say that the parallel was academic. In that case, the “comparator” business model that one would inevitably encounter would be the one where the property was fully developed, and then sold as a single supply. It would then be irrelevant, almost superfluous, that the VAT legislation clearly allows the construction services to be zero rated.
 
And that was the very argument which the Lower Tribunal, on first hearing the case, accepted. The supply splitting occurred in the face of an overwhelming industry norm of full development. Furthermore it held that commercial reasons for the split were over-stated and the fiscal benefits were key. Therefore, and seemingly forgetting the fact that the VAT Act plainly allows construction to be zero rated when supplied separately, it found in favour of HMRC and agreed that VAT applied to the combined turnover of both companies.
 
But the Upper Tribunal, to which Lower Mill appealed, could not have disagreed more strongly. The land sale, followed by separate construction, approach was a perfectly viable business model in this industry. The expert witness had cast no doubt on that. The tax payer’s stated motive for splitting being one relating to project finance had been rejected out of hand, for no apparent reason. He had been unfairly called a liar. Furthermore, it was difficult to see in what way the use of two suppliers, making two supplies of products which were easy, in practical terms, to supply separately and successively, trampled on the purposes or intentions inherent within the VAT Directive. The Upper Tribunal could not see it that way.
 
Well, that seems like common sense.  Why, if the VAT Act allows a zero rate for constructing residential accommodation despite a planning restriction that it be used only for holiday purposes, should there be any question as to not allowing a business to adopt a perfectly sensible business model along such lines?
 
 
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