In this post, Jack Prytherch, Of Counsel in the Tax team at CMS, previews the decision awaited from the Supreme Court in Moulsdale t/a Moulsdale Properties v Commissioners for His Majesty’s Revenue and Customs. The appeal was heard by the Supreme Court on 17 January 2023.
The Supreme Court was asked to consider whether a sale of property by the appellant (“Moulsdale”) was exempt from VAT. More specifically, the Supreme Court considered whether Moulsdale intended or expected that the property sold was or would be a capital item in the hands of the purchaser for the purposes of the Value Added Tax Act 1994 (“VATA”), Sch 10, resulting in Moulsdale’s option to tax being supplied.
A supply of property (including land and buildings) is normally exempt from VAT. This means that no VAT is chargeable on the supply and, by extension, that the person making the supply cannot recover any input VAT incurred on their own expenses. However, it is possible for the owner of the property to “opt” to tax, meaning that a supply of the property will generally no longer be treated as exempt (and any associated input VAT is therefore recoverable).
An option to tax cannot normally be revoked until at least 20 years have passed. However, VATA, Sch 10, contains certain statutory provisions which have the effect of discharging an option to tax so that a supply of the property in question will nevertheless be treated as exempt. In particular, VATA, Sch 10, paragraphs 12-17, contain “anti-avoidance” provisions originally designed to negate a form of VAT cashflow planning. These anti-avoidance provisions require, inter alia, that the land to which the supply relates must be, or is intended or expected to be, a “capital item” in relation to the grantor or the transferee. The term “capital item” is an item on which the owner incurs VAT bearing capital expenditure pursuant to the VAT capital goods scheme (Value Added Tax Regulations 1995, Pt XV), which broadly requires a person to make input tax adjustments in respect of certain capital items over a period of up to ten years.
In this case, Moulsdale purchased land, on which a block of offices had been built, from a developer in 2001. The developer had opted to tax the property, meaning the purchase price included an amount in respect of VAT. Shortly thereafter, Moulsdale also opted to tax the property and leased the offices to a connected person. Although Moulsdale initially charged VAT on the rent to the connected person, he was later told by HMRC that this was incorrect on the basis that the connected person’s business was involved making exempt supplies. As a result, Moulsdale was forced to reclaim the VAT paid on the rent, with the practical effect that he could no longer offset this against the VAT incurred on the purchase of the land.
In 2014, Moulsdale sold the property to an unconnected third party (subject to the continuing lease). Despite the fact that Moulsdale had opted to tax the property, he did not charge VAT on the sale, relying on the anti-avoidance provisions in VATA, Sch 10. The question before the Supreme Court was whether Moulsdale was correct to do so.
The property could not have been a capital item in relation to Moulsdale because the ten-year adjustment period under the VAT capital goods scheme had expired. The dispute was therefore focused on whether Moulsdale intended or expected that the property would become a capital item in relation to the purchaser.
Decisions of the Tribunals
Prior to the First-tier Tribunal (Tax Chamber) (“FTT”), it was accepted by both parties that there was an inherent circularity in the application of the anti-avoidance provisions in VATA, Sch 10.
If property is the subject of an option to tax, VAT should be chargeable on a supply of that property, thereby (subject to certain conditions) creating a capital item in the hands of the transferee. However, at that point, the anti-avoidance provisions in VATA, Sch 10, would then apply the option to tax, meaning that VAT would no longer be chargeable on the supply of the property, meaning that a capital item would not be created. In turn, the provisions in VATA, Sch 10 would then be switched off and VAT once again chargeable, and so on.
Both parties agreed that the anti-avoidance provisions in VATA, Sch 10, had to be construed so as to avoid this circularity, but they disagreed on how this should be done. Counsel for Moulsdale argued that one must assess the grantor’s intention or expectation while ignoring any disapplication of the option to tax which the provisions in VATA, Sch 10, might effect. Counsel for HMRC, on the other hand, argued that the capital item created by the grant must be ignored when deciding whether the option to tax is disapplied by the anti-avoidance provisions.
The FTT dismissed the appeal, not favoring either party’s proposed statutory construction. The FTT held that the critical issue was Moulsdale’s subjective intention or expectation at the time of the sale to the third party purchaser. The FTT applied that test by reference to Moulsdale’s knowledge of the transaction rather than the convoluted statutory provisions in VATA, Sch 10: simply put, Moulsdale had not charged VAT and therefore cannot have intended the property would become a capital item in the hands of the purchasers.
On appeal, the Upper Tribunal (Tax and Chancery Chamber) (“UT”) held that the FTT had correctly identified the question as being whether the property was intended or expected to be a capital item in the hands of the purchaser. The UT further held that the FTT’s findings were supported by the agreed facts and their conclusion was one which they had been entitled to reach. Critically, Moulsdale had not provided evidence of his subjective expectations or intentions in relation to the status of the property as a capital item in the hands of the purchaser. The UT therefore dismissed the appeal.
Decision of the Court of Session
The Court of Session, by a majority of 2:1, agreed with the FTT and UT and dismissed the appeal.
In the majority, Lords Carloway and Menzies held that, in order to succeed in his appeal, Moulsdale had to demonstrate that the option to tax had been disapplied because he intended or expected that the land would become a capital item in the hands of the purchaser . This involved a subjective test and the burden of establishing it rested with Moulsdale. The problem for Moulsdale was that he did not lead to evidence of his subjective expectations or intentions on this critical issue and, as such, there were no grounds justifying the reversal of the FTT and UT’s decisions on what was ultimately a matter of fact.
Dissenting, Lord Doherty focused instead on the issue of the circularity in the legislation. It was common ground that the provisions in VATA, Sch 10, had to be construed so as to avoid this circularity. Lord Doherty favored Moulsdale’s proposed construction, dismissing HMRC’s alternative construction as “untenable”. Although Moulsdale clearly believed that the option to tax would have been applied, it was a “necessary and integral element” of that belief that the anti-avoidance provisions in VATA, Sch 10, were satisfied – which in turn required that he intended or expected that the property would become a capital item in relation to the purchaser. In Lord Doherty’s view, therefore, the FTT and UT had fallen into error.
As should be clear from the above, the relevant statutory provisions in this area are highly complex (or, as Lord Menzies put it, “unnecessarily convoluted”). It is hoped that the Supreme Court will finally bring some resolution as to the proper statutory construction so as to avoid the inherent circularity of the anti-avoidance provisions in VATA, Sch 10.