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HMRC internal manual

VAT Land and Property

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Option to tax - anti-avoidance test: what changes have been made to the anti-avoidance measures?: changes effective from 18 March 2004

Schedule 10 paragraphs 12(6) and 13(7) (formally paragraphs 2(3B) and 3A(2A). Also Article 5(2B) of the VAT (Special Provisions) Order 1995 - SI 1995/1268

The Problem

Taxpayers were able to avoid disapplication of the option to tax by ensuring that lease supplies made to the partly exempt business were made by someone other than the person that made the original grant.

There are many variants to the schemes, but in its common form an unconnected developer would grant a lease to the partly exempt business (the user) then sell the property with the benefit of the lease to the SPV. Prior to 18 March 2004, the SPV was not caught by the test because it had not made the original grant. As a result of the sale, the property would become an asset of the partly exempt user’s corporate group, but as the sale was treated as a TOGC no irrecoverable VAT was incurred.

As an alternative, where the SPV was a subsidiary of the developer, the TOGC would be followed by the sale of the shares in the SPV to the partly exempt business.

As a consequence of either structure the only irrecoverable VAT (on the rent charged by the SPV) could be spread over a number of years.

The Solution

Two main changes were made. The first increased the scope of the anti-avoidance legislation in Schedule 10, VATA 94, whilst the second added a further qualifying condition to the TOGC provisions (Value Added Tax (Special Provisions) Order 1995). The changes were as follows:

  1. Anti- avoidance provision

Paragraphs 2(3B) and 3A(2A) of Schedule 10 (currently paragraphs 12(6) and 13(7)) were introduced from 18 March 2004. Following the amendment, any person making supplies under a grant made originally by someone else was required to apply the anti-avoidance test as if they had made the grant. The grant was treated as made at the time they made their first supply arising from the grant. Where the first supply was made prior to 18 March 2004 the test was still applied at the time of the first supply but the option was only disapplied in relation to supplies made on or after 18 March 2004.

Example: ‘A’ has leased a property to ‘B’ and then sold the freehold to ‘C’ so that ‘B’ becomes ‘C’s tenant. If the sale to C is a TOGC on 1 November 2003 and C makes its first supply under A’s lease on 1 December 2003 then, for the purposes of C’s disapplication test, the ‘grant’ is treated as made on 1st December 2003.

If, as a result of the test, C’s option to tax is disapplied then any supply under the lease made on or after 18 March 2004 is exempt, whilst supplies made from 1 December 2003 to 17 March 2004 are not caught by the disapplication test and will be standard rated. An important feature of the amendment was that any grant caught by the additional provision was deemed to have been made at a time when the property was within the capital goods scheme adjustment period. This meant a taxpayer could not avoid disapplication by delaying the first supply until after the expiry of that period.

A further minor change confirmed that for the purposes of the ‘financing’ test provision of consideration for acquisition of shares or securities was treated as ‘provision of funds’.

  1. Transfer of a Going Concern (‘TOGC’)

Where the vendor has opted, the transfer of a property can only be treated as a TOGC if the transferee has also opted and notified his option by the relevant date. Before 18 March 2004 this condition was still met even if the transferee’s option to tax had been disapplied. Following changes made from this date to the TOGC provisions (in particular the introduction of Article 5(2B) of the VAT (Special Provisions) Order 1995 - SI 1995/1268) a sale can only be a TOGC if the transferee has both made an option and notified the transferor that it is not disapplied.

Under the revised provisions a sale can only be treated as a TOGC if the transferee notifies the seller that Article 5(2B) does not apply. Article 5(2B) applies if two conditions are met:

  • (i) as a result of the transfer (either as a TOGC or a supply) the asset would become in relation to the transferee a capital item, and
  • (ii) the transferee’s option to tax would be disapplied.

Without such a notification the sale of the property is not a TOGC.

For further details on how these rules are applied see Section 11 of Notice 742A Opting to tax land and buildings.