HMRC Reinterprets VAT Law After Newnham College Ruling

by Robin Pilgrim, LawAndTax-News.com, London

11 June 2009

HM Revenue and Customs (HMRC) has revised its interpretation of the law following last year's judgment of the UK House of Lords in the case of Newnham College in the University of Cambridge, which was permitted to reclaim input tax on the costs of building a new library.

A Revenue and Customs Brief 33/09, issued by HMRC on June 8, explains HMRC's revised interpretation of 'occupation' for the purposes of taxation following the release of the judgment, and provides guidance for those businesses affected by the judgment.

As an educational institution – and therefore exempt from value-added tax (VAT) - Newnham College set up a scheme that would allow it to recover VAT on the cost of building a new library. In doing so, the college leased the completed library to a subsidiary company, set up prior to the building’s construction, for a term of 11 years.

The college elected that the grant of the lease to the company should be treated as a taxable supply for VAT purposes, therefore enabling it under the VAT Act 1994 to recover all the input tax attributable to making that supply. In doing so, the college saved GBP1.3m in tax. However, HMRC objected to the use of such a scheme and pursued the issue through the courts.

The case concerned whether Newnham was 'in occupation' of the college library. If they were, their option to tax the library would be disapplied and their occupation would be for the purpose of making supplies of exempt education. Consequently, the VAT incurred on the rebuilding and refurbishment of the library would be irrecoverable. The House of Lords upheld the judgment of the Court of Appeal and found in Newnham's favour. They concluded that Newnham was not in occupation and, as a result, that their option to tax was not disapplied.

According to the Revenue and Customs Brief:

“HMRC now accept that physical presence alone is not the correct test of occupation for the purposes of what is now VATA 1994 Schedule 10 Paragraphs 12 to 17 (the 'anti-avoidance test'). Following the House of Lords judgment, a person is considered to be 'in occupation' if, in addition to physical presence which occupation normally entails, they have the right to occupy the property as if they are the owner and to exclude others from enjoyment of such a right. This means a person must have actual possession of the land along with a degree of permanence and control. Such a right will normally result from the grant of a legal interest or licence to occupy. Occupation could also, however, be by agreement or de facto and it is therefore necessary to take account of the day to day arrangements, particularly where these differ from the contractual terms. An exclusive right of occupation is not a requirement; an agreement might, for example, allow for joint occupation. Equally, it is not necessary for a person to be utilising all of the land for all of the time for them to be considered as occupying it.”

“A person whose interest in land is subject to an inferior interest, such as to prevent him from having rights of occupation for the time being, is not 'in occupation' for the purposes of the anti-avoidance test until the inferior interest expires. It should be noted, however, that an important feature of the test is that it is forward looking and takes account of the intended or expected occupation of the building at any time during the Capital Goods Scheme adjustment period. As a result, a person who has granted an inferior interest but intends during that adjustment period to occupy the land himself would intend to be 'in occupation' for the purposes of the anti-avoidance test and so must consider whether his intended occupation was for eligible purposes.”

However, HMRC stated that a person can ignore the following types of occupation for the purposes of the test:

• Occupation which is purely for the purpose of making his rental supplies under the grant, since those are the very supplies whose liability he is trying to determine by applying the test. For example:
  • occupation by the grantor between the date of the grant and the start of occupation by the tenant which is for the purpose of undertaking refurbishment or repairs,
  • occupation by maintenance, security or reception staff (or similar), unless it is for the purpose of providing ongoing services separate from the letting itself.
• Occupation at a future date, but within the CGS adjustment period, which is solely for the purpose of re-letting the property or making a fresh grant.

HMRC stated that businesses that were wrongly denied input tax recovery may submit claims to their local Business Advice Centre. These will be subject to a three-year limitation period (four years from April 1, 2009, subject to a transitional period).

“All such adjustments or claims must take account of any under-declared output tax as a result of incorrectly treating the option to tax as disapplied,” the department explained.

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