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VAT planning must reflect economic reality

Debbie Jennings

While tax planning is a sensible and expected part of running a business, that planning must be based on substance and the reality of the situation. This point was recently highlighted by the Upper Tribunal decision involving the Royal College of Paediatrics.

The college was looking to buy a building and, because the vendor had opted to tax, the transaction would be subject to VAT. Much of this VAT would be irrecoverable by the college and so effectively represented an increase in the purchase cost. However, if the college were to buy an investment property business, the transaction could be treated as a transfer of a business as a going concern (TOGC), meaning that no VAT need be charged.

“The space in the building was larger than the college needed, so it was looking to rent out some part of it,” says Debbie Jennings, a VAT director with Moore. “The college therefore suggested to the seller that the sale be structured so that the TOGC rules could be applied. As there were no tenants currently in place, the college introduced a tenant to the vendor.”

On the face of it, the subsequent sale might appear to qualify as a TOGC, and this was the view of the First-tier Tribunal. But the Upper Tribunal disagreed on the grounds that there wasn’t enough economic reality to the arrangement. It honed in on the fact that the tenant would only be renting one room in what was a substantial building. In addition, the tenancy agreement between the vendor and the tenant was made conditional on the sale to the college going ahead.

“An important aspect of running a business is that you take on risk in return for reward,” Debbie says. “In this case, the vendor had no risk in the tenancy agreement, because it was conditional on the property sale. The economic substance just wasn’t there.”

The case doesn’t just offer a lesson relevant for property transactions, Debbie feels. “There is an important lesson for VAT planning in general,” she says. “The practical reality of the situation must fit the planning, and the execution needs to be robust. In this case, the facts didn’t stack up when closely scrutinised.”

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 VAT team