The Court of Appeal held that the supply made by a third party to the taxpayer under the terms of contractual arrangements between them relating to a number of leasehold properties owned by the taxpayer was not an exempt supply of the leasing or letting of immovable property for VAT purposes within art. 13(B)(b) of Council Directive 77/388.

Facts

The taxpayer, a high street bank, made predominantly exempt supplies of financial services and could recover only a small proportion of the input tax incurred in carrying on its business. In 2000, the taxpayer decided to transfer its interest in a large number of freehold and leasehold properties to an independent third party (M) and lease back those properties which it wished to occupy. This arrangement had a number of commercial advantages for the taxpayer. There was no difficulty in transferring the freehold properties or assigning the long leasehold interests. However, since consent of the landlords was required for the assignment of most of the short-term leases and it was considered that such consent would not be forthcoming, the concept of virtual assignment was developed. That provided for the taxpayer to transfer the benefits and burdens of the leases to M while remaining in occupation of the properties and paying a principal fee to M equivalent to the rent it would have paid had a formal leaseback occurred.

Customs took the view that, under the virtual assignment, the supply by M to the taxpayer was not an exempt supply to the taxpayer of the leasing or letting of immovable property within the meaning of art. 13(B)(b). The principal fee paid by the taxpayer to M was partly to reimburse M for paying the rent due from the taxpayer to its landlords, only the remainder being for standard-rated supplies of agency and property management services. The VAT tribunal held that Customs had been correct in so deciding.

Further, under the virtual assignment, the rents of the under-leases ‘accrued’ to M within the meaning of para. 8(1) of Sch. 10 to the Value Added Tax Act 1994, so that M was to be treated as the person who made the exempt supplies to the under-tenants; when the rents of the under-leases were paid to M they did not constitute consideration paid by the taxpayer for standard-rated supplies of agency and property management services. Customs had been wrong to decide that where relevant premises were subject to underleases granted by the taxpayer transferring the economic benefit to M, the rents due to the taxpayer under those underleases were consideration for the standard-rated supplies of agency and property management services made by M to the taxpayer ([2004] BVC 2,367; Decision No. 18,666). The High Court allowed the taxpayer's appeal and dismissed the Crown's cross-appeal, holding that, for VAT purposes, the word ‘letting’ in art. 13(B)(b) of the sixth directive included the situation where no right of occupation was in fact granted ([2005] BTC 5,300). Customs appealed to the Court of Appeal.

Issue

Whether a ‘letting’ for the purposes of the sixth directive necessarily connoted the grant of a right of occupation or whether it included also a grant of a right to enjoy the fruits of the property.

Decision

Jonathan Parker LJ (May LJ and Sir Peter Gibson agreeing) said that the European Court of Justice (‘ECJ’) had made numerous preliminary rulings directed at the correct interpretation of the expression ‘leasing or letting’ in art. 13(B)(b) and that it was not necessary to refer a question to the ECJ for a preliminary ruling.

The art. 13(B)(b) issue had to be addressed in two stages. The first stage was to analyse the nature and effect of the contractual arrangements between the taxpayer and M (i.e. the master agreement and the virtual assignment). The second stage was to determine whether contractual arrangements of that nature and having that effect fell within art. 13(B)(b).

The first stage was exclusively a matter of national law; the second, by definition, was exclusively a matter of Community law.

The first stage: National law

It was common ground that the contractual arrangements did not involve the transfer of any proprietary interest in the properties in question from the taxpayer to M, whether at law or in equity. Further, they did not, and were not intended to, transfer to M any contractual right to occupy the properties (for obvious reasons, given the existence of covenants against parting with possession without the consent of the landlord). In consequence, the taxpayer's status as tenant remained the same after as before the execution of the virtual assignment: it continued to occupy the properties the subject of the virtual assignment in right of its status as tenant under the leases. It followed that since M had itself no proprietary or contractual right to occupy the properties in question, it was not in a position to ‘lease back’ (in the sense of re-transfer) such a right to the taxpayer. The contractual arrangements between the taxpayer and M were effective merely to regulate, as between the two of them, the taxpayer's exercise of its continuing right (qua tenant) to occupy the properties.

The second stage: Community law

It was clear on the face of art. 13(B)(b) that the expression ‘leasing or letting’ when used in the article had a wider meaning than it did under English law (see, for example, the exclusion of hotel accommodation). At the same time, the European authorities stressed repeatedly that the exemptions in art. 13(B)(b) were to be interpreted strictly.

The Community law authorities left no room for doubt that a right of occupation was an essential and fundamental element of a transaction of leasing or letting for the purposes of art. 13(B)(b). It followed that since M had acquired no right of occupation of the properties the subject of the virtual assignment, and hence was never in a position to transfer such a right back to the taxpayer, the supply made by M to the taxpayer under the contractual arrangements in question was not a supply of ‘leasing or letting’ within the meaning of art. 13(B)(b) and hence was not exempt from VAT. Accordingly Customs were correct in characterising the supply by M as a standard-rated supply of agency and property management services.

Article 13(B)(b) could not include a situation where no right of occupation was in fact granted and it could not be said that the contractual arrangements between the taxpayer and M ‘reproduce the essential features of a letting’ since one essential feature of a letting was missing, viz. a right of occupation (C & E Commrs v Mirror Group plc (Case C-409/98) [2001] BTC 5,547; [2001] ECR I-7175, C & E Commrs v Cantor Fitzgerald International (Case C-108/99) [2001] BTC 5,540; [2001] ECR I-7257, EC Commission v UK (Case C-359/97) [2001] BTC 5,383; [2000] ECR I-6355, Maierhofer v Finanzamt Augsburg-Land (Case C-315/00) [2003] BTC 5,269; [2003] ECR I-563 and Lubbock Fine & Co v C & E Commrs (Case C-63/92) [1994] BTC 5,003; [1993] ECR I-1665 considered).

In the instant case, the taxpayer was attempting to have it both ways. Any grant by the taxpayer to M of a proprietary interest in the properties in question required its landlords’ consent, as did any conferring by the taxpayer on M of a contractual right of occupation of those properties. Hence, given the absence of such consent, the need to resort to the device of a virtual assignment designed to produce the same commercial results, but without involving the taxpayer in doing either of those things. Yet the taxpayer was now contending that for VAT purposes it was to be treated as having done precisely that which the virtual assignment was specifically designed not to do. Therefore, the tribunal had reached the right decision on the art. 13(B)(b) issue for the right reasons.

Court of Appeal (Civil Division). Judgment delivered 29 June 2006.