A functional approach to the VAT land exemption

The FTT has held that the provision of accommodation to persons at a YMCA was a supply of land, despite the existence of a clause in the contractual documentation stating that there was no supply of exclusive possession of the bedrooms: City YMCA London v HMRC [2021] UKFTT 0477. The FTT considered that a functional analysis was more important for the correct determination of the supplies being made than the contractual provision in this case.

The FTT also held that the supply fell to be treated as one of sleeping accommodation in a hotel or similar establishment, taking it outside the VAT exemption for land. The result of the decision was that the YMCA was able to account for VAT on only 20% of the payments received for accommodation that was used for 29 days or more under the advantageous “28 day rule”, whilst still obtaining input VAT recovery on its costs of running the accommodation.

The decision is interesting in applying a functional approach to the VAT exemption for land and the exception for sleeping accommodation. The FTT was critical of HMRC for relying on a simple contractual provision to technically exclude exclusive possession, rather than applying an economic and commercial reality test which clearly indicated that the accommodation in this case qualified for the treatment argued by the taxpayer.

Background

Historically, the YMCA had provided temporary accommodation for between a few days and two years to homeless persons in on-site bedrooms, together with access to communal cooking and eating areas. The YMCA had treated these as supplies of land and, in principle, within the exemption from VAT. However, it accepted that these supplies were then covered by the exception to exemption in Item 1(d) concerning “the provision in an hotel, inn, boarding house or similar establishment of sleeping accommodation”, bringing them back within the charge to VAT. The majority of residents at the YMCA remained for longer periods and this allowed the YMCA to take advantage of the “28 day rule” in VATA 1994 Schedule 6 paragraph 9, whereby the value of the supply is assessed at 20% of the full value after 28 days.

Following a review, HMRC determined that the supplies by the YMCA did not fall within the land exemption. In particular, HMRC took note of Clause 7 of the agreement between the YMCA and persons staying at the YMCA which stated that: “This agreement is not intended to confer exclusive possession on the Licensee nor to create the relationship of landlord and tenant between the parties.”

HMRC argued that exclusive possession was a fundamental aspect of the grant of a lease or licence to occupy. This was clear from ECJ cases such as Belgian State v Temco Europe SA (Case C-284/03) where it was accepted that “the court has defined the concept of the letting of immovable property… as essentially the conferring by a landlord on a tenant, for an agreed period and in return for payment, of the right to occupy property as if that person were the owner and to exclude any other person from enjoyment of such a right …”. As a result of Clause 7 it was clear that no such exclusive right was granted.

The YMCA argued that Clause 7 had been included in the contractual terms simply to ensure that residents did not get statutory rights as a tenant. In any event, it was clear that in applying the VAT rules it was important to have regard to the economic and commercial reality and not mere labels included in the contractual terms. On the facts, it was clear that residents did in fact obtain exclusive occupation of the bedrooms subject only to the YMCA’s right to obtain access for normal purposes, such as servicing and repairs. The YMCA could also require residents to move rooms, but this was only rarely done, for example to make available a room for a disabled person on the ground floor.

Supply of land?

The FTT stressed that it is important to distinguish the Community law definition of leasing or letting from the legal concepts of leasing or letting under national law and considered that the “blurring of this distinction would seem to be the origin of the [HMRC’s] ruling that led to the appeal”.

The FTT considered that the question was whether the economic reality of the supply involved the YMCA assigning the use and enjoyment of a bedroom to a resident, to the exclusion of all others, including the owner, for a period of time, in exchange for a price. Despite the wording of Clause 7, the FTT had no problem in holding that it was clear that residents did, in essence, have exclusive use of bedrooms. The criterion ‘to the exclusion of all others’ essential to defining ‘the leasing or letting of immovable property’ for Community law purposes set out in Temco was met in the supply made by the YMCA, notwithstanding the restrictions provided in the agreement.

“Taking a functional approach, the economic reality for ‘the leasing or letting of immovable property’ is concerned with the ‘use and enjoyment’ of the habendum ‘to the exclusion of all others’. While the existence of a right in the form of ‘exclusive possession’ is one way of establishing that there is a transfer of ‘the use and enjoyment to the exclusion of all others’, it is not the only way to ascertain if the criterion is met. It seems to me, the fundamental flaw in the respondents’ position is to start with the legal classification of ‘exclusive possession’ for the purpose of informing the construction of the second criterion. By adopting the legal concept of ‘exclusive possession’ to interpret the essential criterion of ‘to the exclusion of all others’ for Community law purposes, other clauses in the Agreement came to be read in the confused light mediated by the conflated meaning.”

HMRC also contended that the supply was not simply one of the provision of accommodation. Rather there was a bundle of elements which made the supply ‘far from passive’ and had ‘added value’ so as to make the land exemption inapplicable. These additional elements included items such as concierge services, cleaning, breakfast and wi-fi access. However, the FTT held that notwithstanding any ancillary elements that were included in the supply made by the YMCA, the essential object of the supply remained that of ‘the making available, in a passive manner, of premises or parts of buildings in return for a payment linked to the passage of time’ in accordance with the ruling by the Court in Temco. As such, there was a single supply in this case which, in principle, fell within the land exemption.

Hotel or similar establishment

The second issue was whether the supply fell within Item 1(d) on the basis that the supply was of sleeping accommodation in a hotel or a ‘similar establishment’. HMRC argued the physical characteristics of the building distinguished it from what would be customarily expected of a hotel, or a budget hotel. However, on this point, the FTT considered that the physical attributes of the premises were not of significance. Similarity was not to be judged by reference to the physical attributes of the premises and the critical factor in determining when exclusion of the land exemption is applicable is concerned with the purpose of the accommodation provision.

HMRC also stressed that the vetting process that residents had to go through to be offered accommodation by the YMCA distinguished the supply from one similar to hotel accommodation. Again, the FTT rejected this approach. “In my view, these factors are not relevant to the determination of whether Item 1(d) exclusion applies. The critical factor in construing ‘similar establishment’ for present purposes is by reference to the temporary nature of the accommodation provision as the purpose of the supply. The phrase ‘similar establishment’ is to be broadly construed with reference to the critical factor, which means secondary factors should not be accorded much weight in the construction. In any event, selectivity is not peculiar to the Supply made by CYL; selectivity is operative in all hotels one way or another, by means of pricing, locality, ambience, choice of niches, and so on. Selectivity is not a relevant factor to determine if the Directive hotel exclusion is in point, in view of the broad construction it is to be given”.

The FTT went on to hold that the principle of equal treatment underpins the broad construction of Item 1(d) exclusion, by having to regard to the function being performed by a ‘similar establishment’. The FTT noted that the phrase ‘sectors with a function similar to that of the hotel sector’ is used in the VAT Directive, and it is clear from ECJ jurisprudence that it is the function performed by a competitor provider to a hotel that the VAT Directive has in mind in order to achieve fiscal neutrality among providers of accommodation similar to the hotel sector. Since in the present case, if a potential resident is not accommodated by the YMCA, the relevant agency or local authority may be sourcing alternative accommodation in a hotel or a hostel, then the FTT considered that Item 1(d) did apply to the supplies made by the YMCA.

Indeed, the FTT went on to state that the “principles of equal treatment and fiscal neutrality are relevant to the construction of Item 1(d), and are far more important than factors as concerns the physical attributes of the premises or criteria relating to selectivity or public access to the supply.”

Comments

The decision provides an interesting and wider perspective on the scope of the land exemption and the exclusion for sleeping accommodation in a hotel or similar establishment. Whilst the contractual provisions are the starting point to determining the correct VAT treatment, they are neither an alternative to the correct application of the VAT rules nor a reason to depart from the economic and commercial reality of the situation.

As such a specific clause introduced in the agreement with residents to achieve a particular aim under domestic landlord and tenant law did not determine the true VAT treatment of the supplies.