UK: Weekly Tax Update - Monday 2 April 2012

Last Updated: 12 April 2012
Article by Richard Mannion


1.1. Finance Bill 2012

The Finance Bill and explanatory notes (issued on 29 March 2012) can be found at:

1.2. Protocol on unscheduled announcements of changes in tax law

The Government has published the process it will follow in respect of retrospective changes in tax law:

The Government has made clear its aim to strike the right balance between restoring the UK tax system's reputation for predictability, stability and simplicity and preserving its ability to protect the Exchequer by making changes where necessary. In particular, changes to tax legislation where the change takes effect from a date earlier than the date of announcement will be wholly exceptional.

1. Ministers undertake to observe the following criteria when considering a change to tax law which will:

  • be announced other than at Budget; and
  • take effect before the legislation implementing the change is enacted..

2. Such changes to tax law will normally only be announced other than at Budget where:

  • there would otherwise be a significant risk to the Exchequer;
  • significant new information has emerged to identify the risk or indicate its scale; and
  • changing the law immediately is expected to prevent significant losses to the Exchequer.

Announcements will usually take the form of a Written Ministerial Statement to Parliament before 2pm..

3. Legislative changes announced in this way will be confined to addressing the risk to the Exchequer that has been identified. A change in HMRC's interpretation of the law (unless prompted by a Court ruling) will not be regarded as 'significant new information'.

4. Where Ministers believe that such a change is justified, the process will be as follows:

  • a Minister will make a public announcement of the intention to change the law and make clear that the change will take effect before the legislation is enacted;
  • the public announcement will be accompanied by the technical detail necessary to amount to a sufficiently clear warning of the nature of the change and its timing;
  • HMRC will publish the Written Ministerial Statement and draft clauses on the HMRC website as soon as practicable after the announcement to Parliament. If, exceptionally, draft clauses cannot be published on the day of the announcement, a detailed technical note explaining the nature of the proposed change and the reasons for it will accompany the announcement; and
  • legislation to give the measure effect will be included in the next available Finance Bill.

5. Whilst the Government will not invite comment on the intention to legislate, the nature of the change or on its timing, it will consult after the announcement to establish whether the draft legislation would achieve its objective and change the law as intended. Subject to the risk of forestalling, consideration will be given to consulting informally in confidence before an announcement is made.

6. As part of the normal Budget process, the Office for Budget Responsibility will scrutinise the estimates of Exchequer impact associated with any change to tax policy.

1.3. Tax consultations tracker

HM Treasury has updated its tax consultation tracker, which sets out a timetable of planned tax consultations for 2012/13, following the 2012 Budget.


2.1. Planning for the drop in the additional rate of tax to 45%

The announcement of a reduction of the additional rate of tax from 50% to 45% from April 2013 provides an incentive for deferring income and/or bringing forward expenditure that is either deductable from or relievable against income. The tax benefits needing to be weighed against the cash flow implications.

Although the focus on such planning will increase in the lead up to 5 April 2013, those with profits assessable based on an accounting date near the start of the tax year should be considering their options now. A sole-trader or partnership with a 30 April year end will be taxed in 2012/13 on the profits of the year to 30 April 2012 with the profits earned from 1 May 2012 being taxable in 2013/14.

Similar timing issues and considerations will apply where there are losses due to the announcement of a cap to apply with effect from April 2013 on 'unlimited' reliefs.

2.2. Discovery assessments – conditions to be met

The First-Tier Tax Tribunal has considered the case of David Stephen Sanderson (TC01902) and revisited the decision in the Veltema case as well as Lansdowne, Corbally-Stourton an the recent case of Chartlon..

In this case the FTT found that that, at the time the enquiry window closed, the hypothetical officer could not have been reasonably expected, on the basis of the information made available to him before that that time to be aware of the insufficiency of tax. It therefore found that the condition in s 29(5) TMA was fulfilled and that HMRC was entitled to raise the discovery assessment.

The key element in this case appeared to be in indentifying the information available in addition to what was shown on the return itself and also what constituted a discovery.

In the additional information, "white space", section of the return, using the specific wording agreed by leading tax Counsel, supplied to Mr Sanderson by Hanover Veriti Limited a promoter of the Scheme in a letter dated 10 June 1999, it was stated:

EUROPEAN AVERAGE RATE OPTION (TRADE NO. 82831) I am entitled to the loss of £1,825,663 by virtue of the provision of TCGA 19992 s 71(2). The loss is part of a loss of £1,000,000,000 which accrued to the Trustees of the Castle Trust on 8 April 1997, on the disposal of a European Average Rate Option (Trade No. 82831) relating to shares in Deutsche Telecom.

BENEFICIAL INTEREST IN THE CASTLE TRUST On 24 November 1998, I purchased for a fee (part of which iscontingently payable) from the Trustees of the Charter Trust 2.273% of their beneficial interest in the Trust Fund of the Cstle [sic] Trust. The interest determined on 25 November 1998, when I became absolutely entitled to receive from the Trustees of the Castle Trust the sum of £16.04.

A possibly significant difference between this 1998/99 return disclosure and that for the one for Charlton in respect of 2006/07 was the absence of a Scheme Reference number.

In that case, although the disclosure did not identify the insufficiency the FTT took the view that no officer could have missed the point that an artificial tax avoidance scheme had been implemented and simply not followed up on the point because "some tax avoidance schemes fail and others do not". Their view was that the notional officer might more sensibly take the view that he should make an assessment, charging the gross gains and disallowing the losses, under the alternative expression, that "some assessments are sustained on appeal, and others are not".


3.1. EMI and CGT entrepreneurs' relief: further information

Budget 2012 announced that, subject to State aid approval, the Government will reform the EMI scheme in Finance Bill 2013 to allow gains made on shares acquired through exercising EMI options on or after 6 April 2012 to be eligible for capital gains tax entrepreneurs' relief. A note has been published which gives further information on the proposed changes.

Proposed changes

To enable shares acquired on exercising EMI qualifying options to qualify for entrepreneurs' relief, despite the individual not holding a 5 per cent stake in the company, the Finance Bill 2013 will make changes as follows:

  • Individuals who dispose of shares acquired on exercising EMI qualifying options will not have to meet the "personal company" condition in relation to that disposal.
  • All other relevant conditions for entrepreneurs' relief will have to be met throughout the usual one-year qualifying period. The company will have to be a trading company (or holding company of a trading group). The individual will have to be an officer or employee of the company (or a member of the group).
  • In addition, the individual will be required to have held the shares disposed of throughout the one-year qualifying period.

To establish whether shares acquired on exercising EMI options after the new rules start (see below), have been held throughout the one-year qualifying period it will be necessary to treat individuals as holding them separately from other shares of the same class they hold in the company. Where individuals dispose of only some of their shares (of the class in question), they will be able to choose which shares they have disposed of in determining whether entrepreneurs' relief is due.


The new rules will apply where shares are acquired on exercising EMI qualifying options on or after 6 April 2012. As shares must be held for at least one year to qualify for entrepreneurs' relief under the new rules, the earliest date on which shares can be disposed of and attract entrepreneurs' relief under the new rules will be 6 April 2013.

3.2. Loans from EBTs and 5 April 2012 deadline

It is quite common for the trustees of an EBT or a related family trust to provide loans to beneficiaries, often unsecured and interest free. The disguised remuneration rules in ITEPA Part 7A now tax such loans (if made on or after 9 December 2010) in full, and there is no clawback if the loan is repaid. Loans granted by the trustees between 9 December 2010 and 5 April 2011 are also subject to Part 7A, but only if the loan remains outstanding after 5 April 2012. There is thus a short window for such loans to be repaid in order to avoid a disguised remuneration charge crystallising on 6 April 2012.


4.1. Corporation tax rates

The corporation tax rates of 24% effective from 1 April 2012 and the 23% rate effective from 1 April 2013 were passed by Budget resolutions 5 and 6 on 26 March 2012 without debate. They are therefore substantively enacted for UK accounting purposes. The following is an extract from the Smith & Williamson alert on the meaning of substantively enacted for accounting purposes:

Under both IFRS and UK GAAP, changes in tax law are not reflected in the numbers included in the balance sheet / statement of financial position until the law has been substantively enacted at the relevant financial reporting period-end date. Only FRS19 and FRS16 specify what 'substantively enacted' means. The date of substantive enactment is either:

  1. the date the Bill has been passed by the House of Commons and is awaiting passage through the House of Lords and Royal Assent; or
  2. the date a resolution that has been passed under the Provisional Collection of Taxes Act 1968.

This definition of the date of substantive enactment is normally also used for international accounting standards. Both UKGAAP (IFRS21 para 22) and IAS (IAS10 para 22) require non-adjusting post balance sheet events to be disclosed if the effect is material. A non-adjusting post balance sheet event includes enacted or announced changes in tax rates after the balance sheet date that will affect current and/or deferred tax.

4.2. European Commission requesting requests UK to amend corporate exit taxes.

The European Commission has issued the following press release:

Brussels, 22 March 2012 – The European Commission has formally requested the United Kingdom to amend its legislation providing for exit taxes on companies.

The UK legislation at stake results in immediate taxation of unrealised capital gains in respect of certain assets when the seat or place of effective management of a company is transferred to another EU/EEA State. However, a similar transfer within the UK would not generate any such immediate taxation and the relevant capital gains would only be taxed once they have been realised.

The Commission considers that the United Kingdom has failed to fulfil its obligations under EU rules by maintaining these restrictive provisions. Exit taxes may breach the freedom of establishment as they make it more expensive to transfer a company seat or place of effective management to another Member State than to another location in the UK.

The Commission's request takes the form of a reasoned opinion (second step of EU infringement proceedings). In the absence of a satisfactory response within two months, the Commission may refer the United Kingdom to the Court of Justice of the European Union.


Exit taxes are taxes typically levied when a legal or natural person leaves a given tax jurisdiction (i.e. change of tax residence), in the case at stake this refers to companies that move their registered seat or place of effective management to another EU/EEA State.

4.3. HSBC and claim for repayment of SDRT

HSBC [and Bank of New York Mellon Corp] has succeeded at the First Tier Tribunal in its assertion that SDRT amounting to £66.2m paid in respect of shares issued and transferred to its depository (Bank of New York) for the American Depository Receipts (ADRs) issued in connection with its acquisition of Household International Inc (Household) between March and October 2003, was unlawful.

Shareholders of Household were given the option of receiving 2.675 HSBC shares for each Household share, or 0.535 ADRs (where one ADR represented an interest in 5 HSBC shares). In addition to the fact that from a US investor's perspective HSBC shares are not shares in a US company, factors that investors might consider when choosing whether to hold shares directly through the share itself, or indirectly through ADRs is the ability they have to vote at company meetings. For these and other reasons it was expected that many Household investors would sell their rights to HSBC shares or ADRs under the takeover offer, and that institutional investors who might take up the rights being sold by others would opt for holding shares rather than ADRs. HSBC therefore agreed with HMRC that there would be a 'flow back' period following the date of the offer, to allow for initial transfer of rights between investors, before the final number of HSBC shares were determined for calculating SDRT (the number of shares required to support the ADRs issued).

While the SDRT was payable by Bank of New York, HSBC met the cost of this. HSBC argued that under the EU capital duties directive Articles 10 and 11 meant that no taxes other than capital duty could be charged on an increase in the capital of a company by contribution of assets of any kind, and that article 12 of that directive concerning transfer (permitting a flat rate charge notwithstanding articles 10 and 11) did not apply. They contended that SDRT was a charge on the issue of HSBC shares or on the issue of ADRs which were certificates representing the shares. HMRC contended that the tax charge did not arise on the issue of ADRs, but on the transfer of HSBC shares to HSBC's depository Bank of New York which was a charge permitted by article 12.

The Tribunal concluded that the transfer of HSBC shares to Bank of New York was integral to the raising of new capital by HSBC, so that levying SDRT on the transfer was in breach of the capital duty directive for both articles 10 and 11. With respect to the application of article 12, the Tribunal concluded that article 12 could not relieve a levy that was unlawful under articles 10 and 11, as it would otherwise defeat the purpose of those articles. They thus concluded that as the shares were effectively the subject of a new issue of securities, (rather than purely the subject of a transfer), it was not lawful to levy SDRT.

During its examination of the issues, the Tribunal also considered beneficial ownership in shares and the different interpretation this could have under UK and US law, as well as the territorial scope of the capital duties directive. In the particular circumstances concerning the HSBC shares, the directive was held to apply and there was sufficient interest in the shares at the appropriate point in time for HSBC and Bank of New York's view to prevail.

If they had decided the transactions had not been unlawful under the capital duties directive, the Tribunal concluded there would have been a restriction in the cross border movement of capital, resulting in a breach of article 56 of the Treaty on European Union (referring to restrictions on the movement of capital and now in article 63 of the Treaty of Lisbon), but that article 57 (providing a derogation from article 56 for restrictions existing on 31 December 1993) would also have applied. There was then an examination of whether that was relevant as the charge to SDRT on transactions, such as the one carried out by HSBC, arose in 1998 when an exemption was removed. The Tribunal concluded that article 57 was not relevant due to the earlier exemption, so that in summary article 56 of the Treaty would have been breached. The Tribunal also concluded that no reference to the CJEU was required as they were of the opinion that the CJEU case law principles were clear in this case and that the capital duties directive applied, so that they could confidently reach a decision. They recognised, however, that they were not a court whose decision was final.

HMRC has announced they have suspended repayments of SDRT pending their decision to appeal this case to the Upper Tribunal.

4.4. HMRC's update on the banking code of conduct

HMRC has issued an update on the banking code of conduct, giving further details on the extent of its implementation.

There are 225 banks that have adopted the code, 169 of which are in local compliance. Included in the documents issued on 26 March is one setting out how HMRC has developed a governance process around communication and escalation procedures in any case where they have concerns about a bank's compliance with its commitments under the Code of Practice on Taxation for Banks. It includes the following comment on tax planning:

HMRC may express concerns whether a bank has met its undertakings under paragraphs 3 to 3.3 of the code where the concerns are that the bank has failed to:

  1. embody the tax planning strategy envisaged by the code in its formal policy, where it has one ; or
  2. adopt this tax planning approach in practice; and give guidance to the bank's operating staff accordingly
  3. review, prior to contracting, all potentially contentious transactions for compliance with this tax planning strategy, involving an appropriate level of tax expertise and challenge, and documenting the review appropriately
  4. enter into or promote reviewed transactions only if its management was satisfied that:

    1. they supported genuine commercial activity
    2. they produced tax results for the bank that are consistent with the underlying economics of the arrangements; or if not,
    3. the tax results they produced were not contrary to the intentions of Parliament, taking into account both a purposive construction of legislation and whether Parliament could realistically have intended the result, given a track record of acting to close loopholes to prevent transactions that are "too good to be true".

  5. take reasonable views in coming to decisions under (iv), where the failure to do so amounts to failing systematically or wilfully to implement its undertakings about tax planning

Evidence of possible systematic or wilful failure may include one or more of the following:

  1. a pattern of executed transactions which are followed by corrective or clarificatory changes to tax law that prevent the intended tax results.
  2. a deliberate or continuing failure by the bank's management to undertake a proper review of proposed transactions; to ensure that it is sufficiently well informed about the transactions and the legislative context for it to take reasonable decisions; or to challenge proposals that are inconsistent with the code.
  3. an approach to the Code which ignores its overall intent of constraining destabilising tax avoidance transactions that are likely to trigger a need for Parliament to consider legislative change.

4.5. HMRC guidance for investment trusts

HMRC has published draft guidance for comment (by 1 June 2012) on the new rules for investment trusts that came into force on 1 January 2012 for accounting periods commencing on or after that date.

4.6. Consultation on 'above the line' credit for research & development expenditure

HM Treasury has published a consultation on introducing the proposed 'above the line' credit for research and development tax relief for large companies in April 2013. Responses to the consultation are requested by 29 June 2012.

The main proposals are:

  • The relief would be in the form of a credit calculated directly on the qualifying R&D expenditure rather than as an adjustment to taxable profits.
  • The credit would be taxable, but would also be repayable (as an amount after tax on the credit) to companies with no corporation tax liability. Two possibilities are discussed, firstly where there is no discount applied to the amount repayable, and secondly where there is a discount applied so that the headline rate of relief could as a consequence be higher. In the case of the situation where there is a discounted repayment, consideration is given as to how this would affect group relief claims, with the implication that particular provision would need to be made to incorporate the amount of the unused credit (the amount not repaid) into any group relief claim.
  • The minimum rate applied to calculate the credit would be 9.1% (assuming the corporation tax rate is 23% in 2013. This delivers broadly the same net benefit as under the existing arrangement. Although not explicitly stated, it would seem logical for the rate of credit to be adjusted as the corporation tax rate changes.
  • If a repayment of the credit is claimed, then the balance of the credit (representing the tax withheld from the payment) could be carried forward for three years so that if the company made a profit in those years, it could be offset against those profits.
  • The government is considering applying the 'above the line' credit system to R&D claims made after 1 April 2013, rather than expenditure incurred after this date. They are also considering whether to make the 'above the line' credit system mandatory, or to keep the existing system operating alongside.
  • There is also a request for information on the potential impact of the credit on US based multinationals where it is indicated that these entities do not benefit from UK R&D relief. This may be the case where the US multinational treats its UK subsidiary companies as transparent (through the check the box system), so that for US tax purposes, the impact of R&D tax relief would be nil. However this presumably would not be the case for US entities which do not check the box for its UK subsidiaries.
  • The government has the impression from earlier consultations that introducing the above the line credit for SME relief would be a complication and currently proposes not to do this. However it has also asked whether respondents to the consultation would support this.
  • Consideration is also given to introducing anti-avoidance rules to prevent, for example, foreign entities setting up a UK branch to access the repayable tax credit without making any real investment in UK R&D, or by carrying minimal or no R&D activities in the UK. There is also a suggestion that if a discounted 'above the line' credit is introduced, there may need to be legislation to prevent artificial diversion of income to a subsidiary to make it profitable to obtain the higher rate of tax relief.

It is to be hoped their will be positive spin offs in terms of increased R&D activity as a result of the above the line credit in April 2013. An above the line credit would separate the benefit of the R&D relief from the tax charge, making it easier to include in calculations supporting R&D investment decisions. It will also give large companies in loss making situations access to a cash repayment for the first time. If simplification was a prime consideration it would seem as though a fully payable and fully group relievable credit would be preferable, though there may be presentational and cost implications to consider with this option.

4.7. Simpler Income Tax for the Simplest Small Businesses

HMRC has issued a consultation paper on the subject of "Simpler Income Tax for the Simplest Small Businesses", following the review carried out by the Office of Tax Simplification.

The following extract is taken from the introduction to the consultation paper.

"There are around 3.5 million individuals undertaking a wide range of trades, professions or vocations in the UK. Of these, more than three million have a turnover below £77,000, which is the VAT registration threshold from April 2012.

At present, all businesses have to use the same rules to work out their trading profits and, therefore, the tax they owe on them. This applies whether the business is a self-employed sole trader starting out or a multinational corporation. These rules are based on accounting practice designed for larger businesses, which means a disproportionate administrative burden in calculating tax for the smallest businesses.

The Government wants to make it easier for the self-employed sole trader or those in partnership with other individuals (later referred to as 'small businesses') to calculate their taxable income, as well as providing them with more certainty over their tax affairs.

What is the Government consulting on?

A simpler tax system for small businesses. The proposals are that small business will be taxed on the basis of the cash that passes through their books, rather than being asked to spend their time doing calculations designed for big business. This is called a voluntary simplified cash basis (later referred to as 'cash basis').

The proposals also include simplifying arrangements for some business expenses (later referred to as 'simplified expenses') to complement the cash basis. The cash basis and simplified expenses will be used to calculate taxable income.

1.7 It is not intended to deliver rules to suit every small business as this would constrain the design and limit the simplification.

HMRC is working with the Department for Work and Pensions to identify how it may be possible to align aspects of the cash basis for tax and self-employment income reporting for Universal Credit.

What is meant by cash basis?

The system will work on a cash in, cash out basis. For income, it's what you receive when you receive it; for outgoings, it's what you pay when you pay it.

What is meant by simplified expenses?

In essence, claiming expenses will be a lot less complicated. Where you can't easily distinguish a business expense from a personal one, simplified expenses will help. For instance, someone working from home will be able to apply a flat-rate deduction for using, say, their household gas or electricity rather than having to make individual adjustments when claiming their expenses."

4.8. Patent Box

A Technical Note on the Patent Box regime has been issued to accompany the clauses in the Finance Bill 2012 published on 29 March 2012, and the associated Explanatory Notes. In addition to outlining the regime, it explains where and why the Finance Bill clauses differ from the draft clauses published in December, and provides more detailed guidance about the legislation and how it is intended to operate.

The main changes (there are other refinements listed in the information note) are:

  • Some consultation responses noted that the draft legislation did not encompass income from territorial licences of a patented invention if the qualifying patent does not cover the territory. The policy objective is to include worldwide income from exploitation of inventions which benefit from a qualifying patent. So the legislation is now amended to achieve this (357CC (6)(b)).
  • Several consultation responses asked for greater clarity about the types of expenditure on which the "routine return" exclusion from qualifying profits (particularly "professional services") is calculated, and considered that the expenditure should not include costs related to acquiring, maintaining or protecting patents. These rules have now been clarified accordingly (357CJ and 357CK).
  • Smaller claims can use a simplified calculation to avoid valuing the contribution of valuable brands, which is excluded from the Patent Box. There is a £1m limit to the profit that can benefit from the Patent Box as a result of this treatment. Consequently the small claims treatment ascribes increasing proportions of profit to brand value as profit subject to the treatment rises above £1.3m. But none the less, there may be some companies whose brand and volume of business drives total profits to well in excess of the small claims threshold, but whose patent derived profit is much less than £1m. To deal with this, in addition to having the threshold, small claims treatment is now limited to companies with profits (before excluding brand) of up to £3m (357CL).
  • The legislation now also specifies its extension to some patents granted by other EEA states (357BB (8)). The Government will make an order to include full patents granted by the national patent offices of Member States which have similar patentability and examination criteria to the UK. Utility patents, and any similar "second tier" rights, will not be included. Patents granted by the following states will be included:



    The Czech Republic











4.9. HMRC guidance on QROPS

Following publication of the Finance Bill, HMRC has issued new guidance on QROPS, applying from 6 April 2012. The updates in the guidance include the following:

  • Clarification on the tests to be an overseas pension scheme and a recognised overseas pension scheme to make the rules work as always originally intended;
  • New member information and signed acknowledgement to be provided to the registered pension scheme (RPS) pre transfer out of RPS;
  • A revised timeframe for an RPS to report a transfer to a QROPS as well as additional information to be provided and a switch to reporting via a paper form;
  • Changes to the period in which a QROPS has to report information to HMRC;
  • Payments by QROPS to be reported within 90 days on a revised paper form;

4.10. Debt buy backs

Following responses to the technical note issued on 27 February regarding anti-avoidance on debt buy-back arrangements (see Tax Update 5 March 2012), the draft legislation issued on 27 February has been updated for the Finance Bill issued on 29 March 2012. A technical note as been issued, commenting on the amendments and containing HMRC's draft guidance on the new rules.

The changes all relate to the drafting of the amended version of section 362 of CTA, except for one small change to the drafting of the retrospective legislation in clause 23(10) of FB 2012.


5.1. Upper Tier Tribunal and abuse of law

HMRC has succeeded in overturning the First Tier Tribunal's decision in the Pendragon case on an arrangement to sell demonstrator cars, applying the abuse of law principle.

The concluding paragraph was:

Our conclusion is that the transactions in this case were an attempt to obtain a tax advantage contrary to the purpose of the relevant provisions and in circumstances where the essential aim of the transactions was to secure that tax advantage. The transactions therefore involved an abuse of law. The transactions must therefore be redefined in the way contended for by HMRC in its decision letter of 22nd October 2001 and be taxed accordingly. We conclude that the FTT committed an error of law in coming to its contrary conclusion and in the result HMRC's appeal against the decision of the FTT must be allowed.

For information, below is the summary included in item 4.1 of Informal of 12 October 2009 on the First Tier Tribunal's decision:

A VAT case on demonstrator cars has clarified that in the particular circumstances involved, the transactions had commercial purpose and were not subject to the abuse of VAT principles.

Following the M&S, Italian and Elida Gibbs cases and the realisation that HM Customs & Excise had been incorrectly requiring motor dealers to block input VAT on demonstrator cars (cars purchased by motor dealers, but used by staff in the motor dealers business), but require them to account for VAT in full on any manufacturer bonuses, the VAT treatment of demonstrator cars for motor dealers was changed from 1 March 2000. From this date, these cars were deemed to be fully VAT qualifying cars if they were intended to be sold within 12 months of acquisition from the manufacturer i.e. VAT was recoverable in full on their acquisition and payable on the full selling price on sale. However there was a requirement to account for output VAT on the use of the car by the employee.

Pendragon plc and others then entered into particular arrangement for financing their demonstrator stock that HMRC held was abusive in terms of VAT. The arrangement worked as follows:

  • New cars were bought from the manufacturer by the dealer and input VAT recovered on the full selling price. These were intended to be sold within 12 months and so were part of their stock in trade and fully VAT qualifying cars.
  • The cars were leased under a hire purchase arrangement by a dealer finance subsidiary to other dealership subsidiaries. The dealers used these as demonstrator cars, so they had an element of private use by their employees.
  • The leases were assigned to a third party bank (Societe Generale in the case of Pendragon), which was held to be neither a supply of goods or services (SI1995/1268). Thus no VAT was payable by the dealership finance subsidiary or recoverable by the bank for the assignment transaction. The consideration for the assignment was the advancing of funds for finance (£20m in Pendragon's case).
  • The arrangement was then an HP lease from the bank to the dealership.
  • The leases were then transferred to a dealership sales company under a TOGC arrangement one month later.
  • The cars were then sold by the dealer companies as agent for the dealer sales company. As the cars had been used as demonstrator cars and the 12 month period for the car to be treated as a fully VAT qualifying car had been broken by the interposition of the external bank, the cars then became second-hand cars for the dealership group and therefore margin cars. Their acquisition price was the VAT inclusive price of the cars subject to the lease, but output VAT due on the ultimate sale was only an any margin received. A comparison of the VAT effect is set out in the table below:


    1. No bank involved

    2. Bank involved


    Gross price

    Net of VAT

    Gross price

    Net of VAT

    (a) acquisition

    20,000 (a)



    17,021 (a)

    (b) Assignment to bank – funds received





    (c) TOGC acquired from bank




    (d) Sale to external individual

    21,000 (d)


    21,000 (d)


    Net profit (d) – (a)





The First Tier Tribunal held that the use the leasing arrangements with the bank were not abusive for the following reasons:

  1. The scheme is not contrary to the purposes of the Sixth Directive. What was done was done in a tax efficient manner but that does not make the essential aim of the scheme to obtain a tax advantage nor was any part of it;
  2. The essential aim of the scheme was to obtain finance not an abusive VAT advantage;
  3. Lord Neuberger's third question (Do any special features of the scheme or law relating to it prevent the abuse argument succeeding - WHA LtdLtd – 2007 EWCA Civ 728) did not need to be considered as the abuse argument has not succeeded. A special feature here would be that the taxpayer has chosen its business structure in such a way as to minimize its VAT liability which is not abusive. The other feature is that second-hand goods are being sold so the margin scheme is supposed to apply.
  4. Recharacterisation is difficult in the circumstances of this case. However if one were needed it would be as a short term leasing transaction.

The Tribunal judge and member also considered whether such a conclusion was: Absurd; Unintended; Disproportionate; Inappropriate; Fraudulent; Unconscionable, or; wrongfully allowing advantages provided for by community law to be obtained; and concluded that it was not.

5.2. Capital costs incurred by a licensee and input VAT recovery

This was an appeal in relation to whether very significant capital costs incurred by Gosling Leisure Limited (GSL), were costs directly and immediately connected with the supplies (all, or possibly only the great majority, of which were standard-rated supplies) allegedly made by GSL. In summary GSL reclaimed input VAT on the construction costs in full initially, claiming that there would be subsequent adjustments under the capital goods scheme for any apportioned non-taxable use of the works. HMRC disputed this, contending initially that input VAT recovery would only apply to 75% of the costs, and then that there was no entitlement at all as the work improved another entity's land. There were some administrative complexities to this case, where HMRC's actions with respect to repayments did not seem to have accorded with the view expressed by their technical division. There was also a late application of costs under the 2009 VAT Tribunal system rather than the new system appropriate to the Upper Tribunal.

GSL was a subsidiary of Gosling Sports Park (GSP) a company limited by guarantee. GSP operated as a trustee of a charitable trust providing recreational and sports facilities for members consisting of football pitches, a running track, a banked cycle circuit, countless covered and open-air tennis courts, a dry ski-slope, badminton courts and several other sporting facilities. GSL had been formed many years ago in response to the charity commissioners' request that the trust's activities consist of purely sporting and recreational facilities. Prior to the construction work GSL provided bar, café and catering services and the provision of an activity area for children. Any profit it generated was gift aided to GSP.

From a VAT perspective GSP's activities were all exempt, while GSL's activities were all standard rated.

The capital costs (amounting to £5m) were incurred on making major alterations completely changing the internal lay-out and configuration of a large pre-existing steel-clad warehouse-type building previously used for playing bowls. The work was to change the entire interior configuration of the relevant building, and build a spa area, to comprise treatment rooms, changing rooms, steam rooms, a very sizable heated spa pool with numerous jets and fountains, and two complex machinery rooms to provide the heating, pumping, and dehumidifying requirements of the spa pool. These changes did not affect the frame, the steel cladding or the fairly low-pitched roof of the building. Whilst the building had been open to the laminated timber joists and steel brackets or the roof when used for bowls, the creation of all the spa facilities resulted in a ceiling being installed above the pool, the machinery rooms and the treatment and changing rooms. This ceiling to the lower floor space created a sufficiently large upper-floor space to facilitate the creation of an enormous gym.

As a consequence of the construction and because the spa and treatment facilities were not 'sporting' for charity and VAT purposes, GSL undertook the spa and treatment activities, receiving all the gross revenues in addition to its other activities. It had operated under an informal licence from GSP for the area required for bar, café, catering and children's activity services, and this then was taken to include the redeveloped area for the spa, pool and treatment services. The licence arrangement was an all encompassing licence that in addition to rent, included a charge for the provision of utilities, staff and the hire of fixtures and fittings.

The construction was completed in 2008, and from 2009, GSP onwards, GSP paid GSL an annual fee of £45,000 for the use of the gym (this was undocumented).

The contentions of the parties were as follows.

GSL contended:

  • the issue of whether it had a sub-lease or even a licence in relation to the building areas on which it had incurred construction costs was irrelevant to its entitlement to an input deduction for those costs;
  • there was a "direct and immediate link" between the expenditure incurred by the Appellant on the construction works, and the supplies made by it because, whatever the property law or contractual position, it was the creation of the new spa and other areas that enabled it to provide the services that it provided, and for which alone it received the consideration; the arrangements between GSP and GSL were not VAT-inspired, but long-term arrangements for a division in activities required by the Charity Commissioners that rendered it essential that it was indeed GSL, and not GSP, that should be providing the various "lifestyle" services that were not strictly sporting activities;
  • if GSL needed some form of licence to sustain its claim for an input deduction, which was denied, the feature that the mislaid management agreement had referred to a "licence of the premises", coupled with the estoppel-like features whereunder GSP had contributed capital to GSL with a view to GSL undertaking all the construction work, and the feature that GSP had plainly known that GSL was treating the product of its expenditure as assets in its accounts, would give GSL whatever legal rights it might need over the buildings in question to sustain its VAT claim.

HMRC contended that:

  • GSL certainly had no sub-lease of the building on which ostensibly it incurred expenditure;
  • the terms of GSP's lease precluded the grant of a sub-lease unless certain formalities were complied with and section 36 of the Charities Act 1993, which was even referred to in the head-lease, contained similar provisions;
  • none of the formalities required under the head-lease or the Charities Act had been complied with, and certainly failure to comply with the formalities under the Charities Act would have rendered any sub-lease purportedly granted void;
  • whilst there was probably no bar in the head-lease to the grant of licences, and certainly none in the Charities Act, there was no evidence that a licence had been granted by GSP to GSL (other than whatever licence over the bar and café areas had been granted by the lost management agreement), and when no break-down was even suggested in relation to the rent payable by GSL for any claimed licence, or the suggested duration or other terms of such a licence, there would be no licence that amounted in VAT terms to a "letting of immovable property";
  • it followed that GSL had incurred capital expenditure on "improving someone else's land";
  • the right analysis was that GSP was conducting the activities from the areas attributed by GSL to its activities, and that GSL was thus just a manager of those activities for GSP;
  • it accordingly followed that there was no "direct and immediate link" between the incurring of the expenditure by GSL and any supplies made by GSL, with the result that GSL was entitled to no deduction in respect of the input tax included in the construction and other project invoices.

The Tribunal concluded as follows:

  • GSL had no sub-lease of any part of the property, but it did have some form of licence to occupy;
  • They disagreed with HMRC's concentration on strict property law and licensing matters, holding that these had little bearing on whether the input tax incurred by GSL was directly and immediately linked to its supplies.
  • As GSL did actually make the purported 'lifestyle supplies and received the gross revenue, it did in fact operate those activities and rendered all the relevant services. They concluded there was nothing odd in the operational relationship between GSP and GSL where GSP seconded its employed staff to GSL.
  • It was therefore clear to the Tribunal that GSL had established that the construction and other project costs that it bore in 2008 were attributable, or directly and immediately related, to the supplies it made.
  • Considering the comments in the CJEU cases of Belgian State v Temco Europe SA (case C-284/03) and Gabriele Walderdorff v Finanzamt Waldviertel (case C-451/06), the Tribunal concluded there were indeed licences in each direction (i.e. both to and from GSL from and to GSP), and that these were exempt licences for the occupation of property.
  • While the Tribunal were not asked to determine the quantum of the claim, they provided some guidance as follows:

In the case of St. Helen's School Northwood Ltd v. HMRC [2007] STC 633, where a swimming pool was used by a school for both standard and exempt supplies, there was simply one indivisible swimming pool principally provided for exempt educational services so that there was no possibility of input VAT recovery in relation to taxable rental of that pool for non-school use. In the GSL case the same result might have occurred if GSL had constructed an entirely separate gym in a separate building, and all the costs of that separate building could be identified. However, absolutely no change had been made to the roof and ceiling of the gym area itself, so that the expenditure on the floor and the few internal partitions appeared to be the only expenditure specifically geared to the gym. If it was accepted that the gym almost materialised by accident at little additional cost other perhaps than the cost of some additional strengthening to the floor, the attributable expenditure might be rather less still.

As a tentative observation the Tribunal commented that they would expect the quantum of disallowed expenditure to be rather less on the approach of trying to identify the gym expenditure in isolation, than the likely disallowance geared to ratios based on the relationship of £45,000 exempt rent to GSL's total income, particularly if the utilisation of the spa area has proved to be rather disappointingly low.

  • Concerning costs, and despite the fact that the earlier costs regime was potentially less beneficial than might have been under the new regime, the Tribunal directed that a previous acceptance by HMRC to costs being determined under the 1986 VAT Tribunal rules should prevail.

5.3. VAT recovery on mansion conversion costs for a hotel business and office complex

One of the basic principles of VAT is that a 'person' may register and reclaim VAT if he is carrying on a business and intends to make taxable supplies. However, problems can arise where HMRC do not believe the person has demonstrated the intention to make taxable supplies to their satisfaction. This can be at the stage of when a business applies for VAT registration or, as in the case of Macaw Properties Ltd which was recently heard at the First Tier Tribunal, sometime thereafter.

There were many complex aspects to the Macaw Properties case, but essentially it considered whether the company had the intention to make taxable supplies and, if so, at what point was the intention made.

Macaw Properties purchased an estate in 1999, which included a substantial Grade I listed house (with the longest façade in the UK and many more rooms of 'the highest order' than Buckingham and Blenheim Palace), a substantial stable block and various other buildings. The company registered for VAT in 2007 (backdated to 2004) and opted to tax the property, on the basis that it intended to convert the main house to a hotel, the stable block into office accommodation and also renovate other areas for business use. Despite HMRC carrying out a detailed review of the company's first repayment VAT return, they later took the view that there was no intention to make taxable supplies and sought to recover the VAT refunded. This view was primarily based on the fact that the company had not yet submitted planning permission, but HMRC had failed to take into account the complexity of Grade I developments.

The Tribunal found that there was sufficient evidence to support the intention to convert the main house to a hotel from the beginning of 2006 and the stable block from the date the company was registered for VAT or earlier.

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