In this post, Jack Prytherch, Of Counsel in the Tax team at CMS, comments on the Supreme Court’s decision in Moulsdale t/a Moulsdale Properties v Commissioners for His Majesty’s Revenue and Customs  UKSC 12, which was handed down on 22 March 2023. The issue before the Supreme Court was broadly whether a sale of property by the appellant (“Moulsdale”) should be treated as exempt from VAT under the Value Added Tax Act 1994 (“VATA ”), Sch 10.
A supply of property (including land and buildings) is normally exempt from VAT. This means that no VAT is chargeable on the supply and, by extension, that the person making the supply cannot recover any input VAT incurred on their own expenses. However, it is possible for the owner of the property to “opt” to tax, meaning that a supply of the property will generally no longer be treated as exempt (and any associated input VAT is therefore recoverable).
An option to tax cannot normally be revoked until at least 20 years have passed. However, VATA, Sch 10, contains certain statutory provisions which have the effect of discharging an option to tax so that a supply of the property in question will nevertheless be treated as exempt. In particular, VATA, Sch 10, paragraphs 12-17, contain “anti-avoidance” provisions originally designed to negate a form of VAT cashflow planning. These anti-avoidance provisions require, inter alia, that the land to which the supply relates must be, or is intended or expected to be, a “capital item” in relation to the grantor or the transferee. The term “capital item” is an item on which the owner incurs VAT bearing capital expenditure pursuant to the VAT capital goods scheme (Value Added Tax Regulations 1995, Pt XV), which broadly requires a person to make input tax adjustments in respect of certain capital items over a period of up to ten years.
In this case, Moulsdale purchased land, on which a block of offices had been built, from a developer in May 2001. The developer had opted to tax the property, meaning the purchase price included an amount in respect of VAT. Shortly thereafter, Moulsdale also opted to tax the property and leased the offices to a connected person. Although Moulsdale initially charged VAT on the rent to the connected person, he was later told by HMRC that this was incorrect on the basis that the connected person’s business was involved making exempt supplies. As a result, Moulsdale was forced to reclaim the VAT paid on the rent, with the practical effect that he could no longer offset this against the VAT incurred on the purchase of the land.
In 2014, Moulsdale sold the property to an unconnected third party (subject to the continuing lease). Despite the fact that Moulsdale had opted to tax the property, he did not charge VAT on the sale, relying on the anti-avoidance provisions in VATA, Sch 10. The question before the Supreme Court was whether Moulsdale was correct to do so.
The property could not have been a capital item in relation to Moulsdale because the ten-year adjustment period under the VAT capital goods scheme had expired. The dispute was therefore focused on whether Moulsdale intended or expected that the property would become a capital item in relation to the purchaser for the purposes of VATA, Sch 10.
The reason for the elevation of this dispute to the Supreme Court was an inherent circularity which both parties agreed existed in the application of the anti-avoidance provisions in VATA, Sch 10. If a property is the subject of an option to tax, VAT should be chargeable on a supply of that property, thereby (subject to certain conditions) creating a capital item in the hands of the transferee. However, at that point, the anti-avoidance provisions in VATA, Sch 10, would then apply the option to tax, meaning that VAT would no longer be chargeable on the supply of the property, meaning that a capital item would not be created. In turn, the provisions in VATA, Sch 10 would then be switched off and VAT once again chargeable, and so on.
As the Supreme Court noted (at ):
“Problems can arise in particular where, as here, provisions that were drafted in an enactment for one purpose are incorporated by cross-reference into a different enactment dealing with something else. The drafter does not spot that there might be a circumstance in which the imported ingredients which work perfectly well in their original setting, create a conundrum in their new setting. If that circumstance arises, it falls to the court to decide how the legislation is enacted, giving effect to Parliament’s intention and the purpose for which the provisions relevant to the appeal were enacted.”
Both parties agreed that these provisions had to be construed so as to avoid circularity, but they disagreed on how this should be done. Moulsdale argued that one must assess the grantor’s intention or expectation while ignoring any disapplication of the option to tax which the provisions in VATA, Sch 10 might effect. As Mr Mousdale had exercised the option to tax, he would ordinarily intend or expect that the would pay VAT on the purchase price. HMRC, on the other hand, argued that the capital item created by the grant must be ignored when deciding whether the option to tax is disapplied by the anti-avoidance provisions.
Decisions of the lower courts
Mousdale’s appeal had been refused by the First-tier Tribunal, the Upper Tribunal and a majority in the Court of Session Inner House. In each case, the critical issue was held to be Moulsdale’s subjective intention or expectation at the time of the sale to the third party purchaser. The First-tier Tribunal had applied that test by reference to Moulsdale’s knowledge of the transaction rather than the convoluted statutory provisions in VATA, Sch 10: simply put, Moulsdale had not charged VAT and therefore cannot have intended the property would become a capital item in the hands of the purchaser. The Court of Session Inner House (by a majority of 2:1) agreed, determining that it was for Moulsdale to demonstrate that the option to tax had been applied because he intended or expected that the land would become a capital item in the hands of the purchaser. This involved a subjective test and the burden of establishing it rested with Moulsdale. The problem for Moulsdale was that he had no evidence of his subjective expectations or intentions, meaning there was no basis to grant the appeal.
Decision of the Supreme Court
The Supreme Court also refused the appeal, but focused on the interpretation of the provisions in VATA, Sch 10 rather than Moulsdale’s subjective intention or expectation.
Lady Rose (with whom Lord Reed, Lord Briggs, Lord Sales and Lord Hamblen agreed) noted that (at ):
“With respect to the tribunals below and the majority of the Inner House, I do not agree that evidence – or the absence of evidence – from a taxpayer about how he or she thought that the statutory provisions would apply to the grant is the key to deciding this case. The taxpayer may have a good understanding of the law and may be well advised or may be unaware of the existence of Schedule 10. That does not affect how the provisions do apply or whether the grant is subject to VAT…”
Although there may be other cases in which the application of the provisions turned on the factual issues, Lady Rose held that in this case there was no such factual dispute: no-one had intended or expected that either Moulsdale or the purchaser would incur any VAT -bearing capital expenditure on the property other than the acquisition cost that would be paid by the to Moulsdale.
The Supreme Court favored HMRC’s proposed solution to the circularity in VATA, Sch 10 on the basis that it made as much sense as one can of the legislation. For the purposes of these provisions, the grantor’s intention or expectation as to the incurring of VAT-bearing expenditure on a capital item must be an intention or expectation about incurring some other cost, different from the very expenditure to which the anti-avoidance provisions in VATA, Sch 10 is being applied, in order to decide whether the sale should bear VAT. The Supreme Court held that, adopting that statutory construction, the question of whether Moulsdale had added sufficient evidence about their intentions or expectations in respect of the grant itself fell away.
The Supreme Court also accepted HMRC’s submission that, in interpreting the provisions, one must start with the principle that these are aimed at ensuring that exempt businesses cannot recover input tax. That purpose would have been defeated on the statutory construction advanced by Moulsdale. Under that construction, the provisions would allow the taxpayer, who has taken advantage of exercising the option to tax its land so as to claim input tax deductions, to then “switch off” that option and make a cheaper, VAT-exempt sale to a non-taxable purchaser.
The relevant statutory provisions in this area are highly complex and their drafting, as the Supreme Court put it, is “unfortunate”. The Supreme Court’s decision therefore provides welcome clarity and resolution as to their proper statutory construction, and may also provide a useful indication of how the Courts would approach similar statutory “conundrums”.