University of Huddersfield: VAT - the abuse principle

The Upper Tribunal (UT) has overturned the decision of the First Tier Tribunal (FTT), finding in HMRC's favour that the University of Huddersfield's attempt to recover input tax on the refurbishment of a property using a lease and leaseback arrangement was an abuse of right under EU principles.

The arrangements

The University of Huddersfield (the University) planned to redevelop one of its properties for use in its educational activities. In order to prevent irrecoverable VAT arising on the services which the partially exempt University received for the redevelopment, it granted a lease over the property to a trust while taking a leaseback. The trust was used to circumvent certain anti-avoidance provisions which would have applied had the lease and leaseback been with a person connected with the University.

Both the University and the trust opted to tax the property and so charged output VAT on the rents under those leases. This also meant that the University, in its capacity as landlord of the headlease, could recover the input VAT on the building costs. It would, however, suffer irrecoverable input VAT on the rents under the leaseback. In this way, the amount of irrecoverable input VAT would be spread over a number of years.

However, the FTT found as a fact that the intention of the University was to collapse the lease and leaseback structure in due course, thus removing the ongoing irrecoverable input VAT for the University and resulting in an absolute VAT saving. The leasing structure was indeed later collapsed, although not until after the University had been assessed by HMRC for the VAT.

Additionally, the FTT found as a fact that there was no commercial purpose to these arrangements beyond the deferral or reduction of VAT.

Arrangements considered as a whole

Relying on the case of Weald Leasing, the FTT had concluded that there needed to be an absolute tax saving, and not just the possibility of one, at the time of assessment. Therefore, unless and until the leases were surrendered, the lease and leaseback arrangements entered into by the University did not constitute an abuse of rights, and the University was entitled to recover the VAT that it had incurred on redevelopment costs.

The UT disagreed. In particular, Weald Leasing could be distinguished on the basis that that that scheme "although entirely artificial … was not intended to have the effect of enabling a partially exempt person to recover input tax to a greater extent than it was generally allowed … The aim of the scheme in Weald was merely to spread the irrecoverable VAT over a longer period of the lease". Using a lease to spread irrecoverable VAT is not, in itself, abusive.

However, the UT considered that the scheme employed by the University went further than spreading the cost of irrecoverable VAT. The University's tax mitigation scheme was intended not only to defer the time at which the University incurred irrecoverable VAT, but also to enable the University to obtain an absolute VAT saving by collapsing the lease arrangements before the irrecoverable VAT incurred on the leases exceeded the input tax on the construction work. In this case, the collapse of the leases should have been considered as part and parcel of the overall tax mitigation scheme.

Application of Halifax test

The UT noted that the fact that a supply is made with the sole intention or purpose of obtaining a tax advantage is immaterial in determining whether it constitutes a supply of goods/services and an economic activity. However, the CJEU in Huddersfield had been clear that the Sixth Directive nonetheless precludes any right of a taxable person to deduct input VAT where the transactions from which that right derives constitute an abusive practice under the two-limb test in Halifax.

As it was accepted that the essential aim of these transactions was to obtain a tax advantage, i.e. the University accepted that the second limb of the Halifax test was satisfied, the question was whether the grant of the tax advantage would be contrary to the purposes of the EU VAT provisions (the first limb).

The tax advantage obtained was the University's treatment of the input tax on the building works as being attributable to the taxable supply of the lease, rather than to its general (mainly exempt) supplies of education, thus enabling a 100 per cent recovery of the input tax instead of a limited proportion.

The UT held that this conflicts with the EU VAT principle that a taxable person must not be entitled to deduct or recover the input VAT paid on supplies received for its exempted transactions. The tax scheme in question was, the UT considered, an artificial attempt to create a taxable supply which had no function other than to enable the deduction of input tax. The University had no need to enter into the lease and underlease, as it already had a leasehold interest entitling it to occupy the premises. Following the refurbishment, the property was going to be used for the general activities of the University, which were primarily exempt. The University's scheme was therefore regarded as an abuse.

As a result, the transactions were redefined to disregard the lease and leaseback in their entirety. This ensured recognition that the refurbishment was undertaken for the University's general purposes, and the University would still be entitled to recover the relevant proportion of tax that it recovers on its general expenditure.

HMRC -v- Huddersfield University

Please click on the links below for the other articles in the October 2014 tax newsletter:

• Skandia: VAT on intra-entity supplies
• Vaccine Research LP: R&D partnership scheme
• Bookit: VAT and card handling fees
• BEPS deliverables
• Taylor Clark Leisure: entitlement to VAT repayments