Moulsdale: circularity of the option to tax anti-avoidance rules

The Supreme Court has adopted a pragmatic approach to the anti-avoidance provisions in VATA 1994 Schedule 10 concerning developers of exempt land in Moulsdale Properties v HMRC [2023] UKSC 12. Whilst acknowledging that a literal reading of the rules would lead to circularity, the Court has preferred HMRC's method to untangle that circularity, adopting a narrow approach to the legislation where land is sold and would become a capital goods scheme item as a result of the value of the sale.

The case is an unusual example of a taxpayer seeking to rely on a wide interpretation of anti-avoidance provisions and HMRC arguing for a narrow interpretation. The Court has, however, confirmed that anti-avoidance provisions should be narrowly construed (even in such a scenario) where they seek to limit a taxpayer's entitlement to a tax benefit, as here.

Background

The case concerned Mr Moulsdale (trading as Moulsdale Properties) who acquired a commercial property in 2001 and opted to tax the property. He then leased the property to a connected exempt trader, Optical Express. Since Optical Express was connected with Mr Moulsdale and occupied the property other than for wholly eligible purposes (meeting the "exempt land test" in paragraph 15 of Sch 10), Mr Moulsdale's option to tax was disapplied in relation to the rentals under the lease by paragraph 12 of Sch 10.

In 2014, Mr Moulsdale sold the property to Cumbernauld SPV, subject to the existing lease. Cumbernault was not connected with Mr Moulsdale or Optical Express. However, despite the existing of the option to tax, Mr Moulsdale did not account for VAT on the sale. Rather he argued that the anti-avoidance provisions in paragraphs 12 to 17 operated to switch off the option such that no VAT was chargeable on the sale.

HMRC contended that the anti-avoidance provisions did not apply to the sale of the property to the unconnected third party and VAT should have been chargeable on the sale. HMRC was successful before the FTT, the Upper Tribunal and the Court of Session.

Decision of the Supreme Court

It was acknowledged by the parties and the Court that the problem with the anti-avoidance provisions (which are, however, not limited to situations involving avoidance) in this case is that, read literally, they were circular.

The anti-avoidance provisions apply where 'exempt land' is transferred by a 'developer'. The question whether a supply is made by a developer depends largely on whether the land is or is expected to become a capital goods scheme (CGS) item. In this case, the land was no longer a capital item for the taxpayer. However, as the sale price for the property exceeded £250,000 and the sale was subject to VAT because of the existing option to tax, it was a CGS item for the purchaser -- unless, of course, the anti-avoidance provisions disapplied the option to tax, in which case, the supply would be exempt. However, this would in turn mean that the land being transferred would no longer be a CGS item for the purchaser and the seller's option would not be disapplied!

As the Court noted, "the conundrum is that if he charges VAT then he is a developer of the land and VAT is not in fact payable because the option to tax is disapplied but if he does not charge VAT then he is not a developer of the land and the option to tax still applies to the sale so that he should charge VAT".

Mr Moulsdale essentially argued that since he had "exercised the option to tax in relation to the land, he would ordinarily intend or expect that Cumbernauld SPV would pay VAT on the purchase price of the land. The inquiry should stop there and conclude that because of that expectation, Mr Moulsdale is to be treated as a developer of the land... The grant is therefore exempt."

HMRC argued that it was necessary to avoid the circularity of the provisions by "recognising that when incorporating the class of assets which are to be treated as a capital item for the purposes of regulation 113 into the definition of "capital item" for the purposes of paras 12 and 13 of Schedule 10, one must disregard the acquisition costs of the building in so far as those acquisition costs are the consideration for the "supply" referred to in para 12(1) of Schedule 10. Put another way, HMRC argue that the way to avoid circularity is by treating the reference to the creation of a capital item as a reference to a capital item other than the one which would arise on the grant".

The Supreme Court has now upheld the decisions of the lower courts, albeit criticising the basis on which those decisions were reached. In particular, the Court did not agree that the decision depended on what evidence there was from the taxpayer as to how he thought the statutory provisions would apply to the sale (for the purposes of the "intend or expect" element of the statutory test). That approach would lead to capricious results based on the taxpayer's awareness or understanding of the law.

Instead, the Court preferred HMRC's interpretation of the provisions. "[F]or 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 test in paras 12 and 13 is being applied in order to decide whether it should bear VAT or not. Adopting that construction of the provisions, the question of whether the taxpayer had adduced sufficient evidence about his intentions or expectations in respect of the grant itself falls away." The test in para 13(4) does not turn on the transaction itself but on what the grantor intended or expected would happen in respect of the land in the hands of the relevant transferee and whether the relevant transferee would incur (other) VAT bearing capital expenditure on it.

This construction was bolstered by the fact that it was necessary to start from the principle that Schedule 10 is aimed at ensuring that exempt businesses cannot recover input VAT. This principle would have been defeated by the construction put forward by the taxpayer in this case. As the Court noted, "the problem with that construction is that it allows the taxpayer who has taken advantage of exercising the option to tax its land so as to claim input tax credits or to spread payments of irrecoverable input tax then to switch off the option to tax and make a cheaper, VAT exempt sale to a non-taxable purchaser simply by intending or expecting to sell the land or building for more than £250,000... the obvious purpose of the provisions would be defeated if they had the effect of rendering a normal commercial transaction such as this one exempt in circumstances where the owner of the land had, presumably for its own advantage, previously opted to waive the exemption and tax transactions relating to the land".

In addition, the Court noted that paras 12 to 17 of Schedule 10 are intended to limit the right conferred on taxpayers to opt to treat their land as generating taxable rather than exempt supplies, when it is to their advantage to do so. These anti-avoidance provisions erode that entitlement and so should be narrowly rather than broadly construed. "It is true that a curiosity of this case is that it is Mr Moulsdale rather than HMRC who is arguing that the anti-avoidance provisions should be broadly construed so as to disentitle Mr Moulsdale's reliance on the option to tax which he has exercised. But that should not stand in the way of the narrow construction."

Comment

The uncertainty caused by the circularity of the legislation has been well recognised, including in Scammell on VAT on Construction, Land and Property, which makes it explicit that that circularity has long been controversial and there is no consensus on the approach to be adopted.

It is perhaps surprising in the circumstances that the Court's comments on this obvious circularity was quite so sanguine -- simply acknowledging that "[d]rafting tax legislation is a difficult and complex task so it is not surprising that sometimes the legislation does not quite work" and that particular problems can arise "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".

Ultimately, however, the decision is in line with HMRC's approach set out in its VAT Land and Property Manual at VATLP23500 that, to avoid the circularity, the CGS item that arises for the buyer should be ignored when determining if the seller's option is disapplied.