4 Eyes Ltd: VAT, Tax and Customs Consultants

The Appellant in this case is a business which repairs aircraft engines. It was the first of four associated businesses to be established, and in 2004 it acquired a long leasehold interest in an airfield with four separate hangars. At a late stage the lessor decided to charge VAT on the lease. The Appellant called HMRC to ask about the VAT and was told that it could recover the VAT provided that it opted to tax. The Appellant did not understand this, but recovered the VAT in full in its June 2004 VAT return without opting.

As the hangars were refurbished and the other two trading companies were established, the Appellant allowed those companies to occupy the hangars which it did not occupy itself. In 2006, the final company, a property rental company, was set up and the entire property was transferred to it. It charges each company a commercial rent, exempt from VAT.

In 2008, HMRC inspected the Appellant and noted the exempt occupation by the trading companies and the exempt transfer of the property to the property company. HMRC issued an assessment against the Appellant on the basis of the CGS, Part XV VAT Regulations 1995.

The CGS is used to adjust the initial deduction of input VAT recovered on property where there is a change, over a ten-year period, in the extent to which the property is used compared to the original or intended use at the time when the VAT was first incurred. The Appellant appealed against the assessment on the basis that there had been no such change in use. It had always been the intention to let the hangars to the associated companies, then to form the property company and transfer the property to it. The error was in the initial deduction of the input VAT. That should have been restricted to take into account the extent to which the Appellant intended to use the property to make exempt supplies, but the Appellant had not understood the effect of not opting to tax and had simply recovered too much VAT in the June 2004 VAT return.

The FTT allowed the appeal.

On the evidence before it, the FTT accepted that the Appellant's business plan had, from the outset, been to establish the four companies and ultimately to have a property company hold the head lease and let the hangars to the other companies. The initial deduction should have been adjusted in the June 2005 VAT return by applying the SMO, reg 107B VAT Regulations 1995. The SMO would have required the Appellant to apply some proxy for the intended exempt use of the property and reduce its initial 100% recovery accordingly. However, HMRC was out of time to apply the SMO to the June 2005 return.

The FTT agreed with the Appellant that, as there had always been an intention to use the property for exempt letting purposes, there was no change in the extent of exempt use and therefore no CGS adjustment was appropriate.

Comment

Where the deduction of input VAT in the first of the ten CGS adjustment periods is incorrect, HMRC can assess subject to the normal four-year time limit. Once that time limit has expired, the initial deduction cannot be adjusted. However, the CGS 'base line' for adjustment is set by reference to the amount of input VAT which should properly have been deducted, not the amount of VAT which was actually deducted. Therefore in a case like this where the intention was always to make exempt supplies and the initial deduction should have been restricted, the CGS base line is the restricted recovery which should have been obtained, and there is no CGS obligation.

Although the outcome in this case may seem a little fortunate for the Appellant, it must be remembered that this is a double-edged sword. A business which fails to deduct enough VAT is subject to the same time limits and the CGS could not be used to recover VAT if too little VAT was recovered at the time of the initial deduction and that was more than four years earlier.

In this particular case, the issue before the FTT was whether, on the evidence, the Appellant really had the intention at the time of the initial deduction of using the property for exempt purposes. Had the Appellant intended to make wholly taxable or mixed supplies of the property, the outcome would have been quite different as the change from that intention to actual exempt use would have engaged either the CGS or the other change of use provisions. It is therefore important, when businesses are making major acquisitions such as property interests, to ensure that the VAT implications are carefully considered.