VAT and business property – make sure that leases are correctly documented

Whether you decide to hold your trade premises within the business, or hold them in a pension fund; personally; or in a separate property company; it is important that you can meet two key requirements (among others) in order to reclaim VAT on any rent paid:-

1. You have a VAT invoice addressed to you; and
2. You can show that the supply was made to you.

Two recent cases highlight what can go wrong if insufficient care is taken over the documentation. As a general principle, Tax Tribunals are loathe to ignore the strict terms of a contract, (including a lease) unless it is clearly at odds with reality.

In August, a Tribunal ruled that a VAT registered company (Star Services Oxford Limited) was unable to recover VAT charged on the rent of premises it occupied.

Factually, the lease and VAT invoice named the Company’s Director, in his own right, as the tenant, not his company. The Director’s evidence was that the lease was entered into before the company was formed, and he “forgot” to have this assigned or novated after the company was formed. He argued that it should be obvious that the Company was the tenant, and the “administrative mistake” should be overlooked.

HMRC’s analysis was that the Director was the tenant, and he sub-let to the Company. Thus, said HMRC, the Company could not reclaim VAT charged on the rent. Nor could the Director reclaim the VAT, because he was not personally VAT registered.

The taxpayer was unable to evidence that the lease didn’t reflect the commercial reality. It didn’t help that while the company was in occupation of most of the property, it was partly sub-let to two other parties, and one sub-tenant paid rent to the company, the other paid rent to the Director personally.

More recently, a Firm of Solicitors (Ashtons Legal - a partnership) was challenged on the basis that the leased property from which it traded was, on paper, let by the landlord to a separate Limited Company. Under the Law of Property Act 1925, only four partners can be named on a lease. HMRC would normally accept that such a lease naming just four partners is “in reality” a lease to the partnership.

However, instead of following HMRC accepted practice of naming four of its Partners on the lease, Ashtons Legal instead decided to form a limited Company to act as nominee. The landlord was willing to have a “shell” company, with £1 share capital and no assets or trade named on the lease, provided the Firm agreed to meet all obligations of the Company in terms of the leases and in particular the Firm guaranteed to pay the rent. All negotiations in relation to the new leases were conducted by, and for, the Firm.

The invoices for rent were addressed to the Nominee Company and HMRC refused to allow Ashtons Legal to recover VAT thereon. According to HMRC, the Nominee Company acted as the Firm’s immediate landlord. The company should therefore have Opted to tax and registered for VAT, treating the rent payable to the landlord as its expense, with it making an onward supply to the Firm of the same value. Of course, if the Company had granted an underlease to the Firm, the same Law of Property Act 1925 issue of naming no more than four partners would have kicked in…

As mentioned above, when deciding “who does what and for whom” the starting point is the contract. Thus, both Star Services Oxford and Ashtons Legal had to show that the economic and commercial reality “trumped” who was shown as the tenant under the lease.

Ashtons Legal was successful on its facts, Star Services Oxford was not. In the former, the Tribunal decided that all parties knew that the Firm had inserted the Company as a nominee solely to deal with the 1925 Act. VAT was therefore recoverable, even though the invoices and lease referred to the Nominee Company.

It is to be hoped that in the light of this case, HMRC clarifies its position on nominees to avoid unnecessary disputes. In the meantime, care is necessary. Star Services Oxford’s reliance on HMRC overlooking an “administrative mistake” was too optimistic.

Ashton Legal may have focussed on land law considerations to the detriment of considering HMRC’s stated position. Even though it was ultimately successful, Ashtons Legal will likely have incurred substantial fees from its Accountants and Counsel in relation to its Appeal, and the previous negotiations with HMRC.