UK: Property Outsourcing - VAT Treatment of Virtual Assignments of Property

Abbey National owned approximately 1,000 properties including some leaseholds of virtually worthless tenancies of high street premises occupied by Abbey's branches. The leasehold properties contained the usual covenant not to transfer or sublet without the landlord's consent.

Abbey entered a sale and leaseback arrangement with a company called Mapeley under which it would sell most of its property portfolio to Mapeley who would then lease back to Abbey the premises Abbey wished to continue to occupy. This arrangement released capital for Abbey which could be invested elsewhere in the business, it transferred the property risk to a third party and enabled Abbey to vacate leasehold property which was surplus to its needs before the term of the lease expired. Mapeley would manage the whole portfolio.

Difficulties arose in respect of the shorter leases where the consent of the landlord to the assignment was required. The consents would take too long to come through and it was thought to be unlikely that the landlords would consent to assignments to Mapeley because it was a new company without a track record showing financial strength. In order to overcome these difficulties the concept of a virtual assignment was developed. Abbey would transfer all the economic benefits and burdens of the shorter leases to Mapeley and Abbey would remain in occupation of the premises and would pay a principal fee to Mapeley which was similar to the rent it would have paid if there had been a formal lease back.

Abbey argued that the virtual assignments should be treated in the same way as actual assignments for VAT purposes and therefore would fall within the exemption from VAT for the grant of any interest in or right over land (which is derived from the EU Sixth Directive exemption for leasing or letting of immoveable property). HM Revenue & Customs (HMRC) argued that the supplies made by Mapeley to Abbey were not exempt supplies but were standard rated supplies of agency and property management services. If the supplies were standard rated Abbey would not be able to recover the VAT because it would be making mainly exempt supplies.

The Court of Appeal has now ruled in favour of HMRC, overturning the decision of the High Court, that the supplies made by Mapeley to Abbey under the virtual assignment arrangements were not a supply of leasing or letting services. The Court held, having reviewed a succession of EU cases, that a right of occupation is a fundamental element of a leasing or letting transaction. Mapeley acquired no right of occupation of the properties as a result of the virtual assignment and so could not transfer this right back to Abbey.

There has been an increasing trend towards property outsourcing over recent years.Virtual assignment was seen as a useful tool for those circumstances, as in the Abbey case, where legal assignments were not possible. This decision could increase costs for financial institutions and others who are exempt or partially exempt from VAT, seeking to outsource, or who may have already outsourced leasehold property. They will either suffer an additional irrecoverable VAT cost or will have to get landlords' consents for all leasehold assignments, which will add to the cost and significantly impact on the timing.