Sarabande v The Commissioners for HMRC

Ms Verkade is CEO of SB. She became CEO in 2020 and prior to that was a SB trustee. She was one of the trustees involved in the decision to acquire and convert the Building. She is also a director of SIL.

The following is a summary of the key points which we found from Ms Verkade’s written and oral evidence:

Ms Fathi is an Artist who had been on the Programme and retained a link with SB. The following is a summary of what we considered to be the key points from her written and oral evidence:

Officer Mathers is and at the relevant time was a VAT Charity Higher Officer in the VAT charity team. He was responsible for the HMRC decision to disallow the VAT Repayment and for the issue of the VAT assessment under s 73 for the same period. Officer Mathers took over the matter from HMRC officers Ricky Sandhu and Christine Marples.

Much of Officer Mather’s witness evidence recounted the sequence of events and the information provided to him by SB’s agents over the course of HMRC’s investigation leading to this appeal. A material amount of that information is included in the background facts and procedural history section of this judgment and we have not, therefore, repeated it in our summary of Officer Mather’s evidence.

The following is a summary of what we found to be the key points from Officer Mather’s written and oral witness evidence:

We were presented with a copy of a contract between Sarabande and Isabel Garrett. This was stated on its face to be a “Lease relating to Studio 8, 22 Hertford Road, London, N1 5SH”.

We also had sight of a contract between Sarabande and Esna Su – which was on materially identical terms save for the rent payable and studio unit leased. We refer to these agreements as the “Leases”.

Key terms (by reference to Isabel Garrett’s Lease) included the following:

SB’s annual trustee reports for 2015 and 2016 indicated that rental income was a small amount which provided a contribution to SB’s costs, with sponsorship and grants making up the bulk of its income.

Following the hearing Mr Zwart submitted what he described as an agreed list of facts setting out what he considered to be points agreed during the hearing. That list was not confirmed by HMRC and so we do not include it in this judgment.

The relevant legislation for the issue of VAT assessments is s.73 VATA.

Sections 25(2) and (3) VATA entitle a taxpayer to a credit or repayment for input tax. Section 26 VATA regulates the amount of input tax which is allowable.

Section 24(1) VATA 1994 defines “input tax” and provides:

Section 25(2) and (3) VATA 1994 provide an entitlement to credit for input tax incurred as follows:

Section 26 provides so far as relevant:

Section 73(1) VATA provides (so far as relevant):

Council Directive 2006/112EC (the Principal Vat Directive or “PVD”) provides, so far as relevant, at Article 135(1)(l) for member states to exempt from VAT:

“the leasing or letting of immovable property”.

This is an exception to the general principle that VAT is to be levied on all services supplied for consideration.

This exemption is contained in domestic law in Group 1, Schedule 9 VATA which provides that, other than in specified circumstances, for:

“the grant of any interest in or right over land or of any licence to occupy land …”

to be exempt from VAT.

SB’s notice of appeal contained an eleven page document outlining the background to its appeal. This concluded that:

“the issue appears able to be determined by the single question of whether the supplies were exempt or were taxable supplies. The recovery of the input tax should follow suit. The Tribunal is requested to determine this Appeal on that issue”

HMRC’s statement of case’s described the “points at issue” as follows:

“33.

Whether the supply from SB to SIL contains a supply of land which is exempt under Schedule 9, item 1, VATA 94

34.

and, consequently whether SB is entitled to claim input tax in relation to these supplies in VAT period 06/18”

Mr Zwart’s skeleton argument and submissions also focused on the nature of the supply made by SB.

We have accordingly limited ourselves in this Appeal to determining whether, on the evidence before us; (i) SB made a supply to SIL and if so whether that supply was an exempt supply of land, and (ii) if not, the nature of the supply made by SB.

Our decision is a decision in principle. It does not consider the sums in question (including the amount of any input tax that may be allowable) as we have not been asked to do so by the Parties and no submissions have been made in that regard.

The burden of proof is on SB to show that HMRC’s assessments are incorrect. The standard of proof is the UK usual civil standard which is the balance of probabilities.

This case has an unusual history. HMRC has been trying for over three years to establish the fact pattern in order to determine the VAT treatment applicable.

SB has made it exceptionally difficult for HMRC to do so. This is because; (i) it and its agents have provided HMRC with entirely inconsistent information as to the arrangements in place between SB, SIL and the Artists, (ii) it seemingly kept no clear records of what those arrangements were – even though external advice was apparently sought and meetings held, and (iii) its accounts (and SIL’s accounts) and their respective VAT returns and direct tax returns appear to have been prepared on an inconsistent basis.

Mr Zwart acknowledged the inconsistency of the information provided and sought to explain this as a consequence of lay trustees being asked technical tax questions and external advisors being led into providing incorrect answers as a result of HMRC’s insistence that a licence to occupy the Building had been transferred by SB to SIL.

Mr Zwart also argued that HMRC failed in its duty to establish properly the facts of the matter before making its decisions. He cited in this regard Secretary of State for Education v Tameside [1977] AC 1014.

We find Mr Zwart’s position difficult to accept.

The advisors who provided the information to HMRC were experienced professionals – a fact verified by Officer Mathers. The information provided from September 2018 to March 2021 by those advisors was unequivocally that SIL and not SB made supplies to the Artists and SB made supplies to SIL. Other than an email from Victor Dauppe (which shortly afterwards was contradicted by Graham Elliott), it was only in August 2021 that SB formally began to claim that SB rather than SIL supplied all elements of the Accelerator Programme (including the studio rights) to the Artists.

We do not agree with Mr Zwart that Tameside provides what might be construed as a defence here - his submission being that it is authority for the proposition that it was incumbent on HMRC to ensure that it had the relevant information needed. That case centred on the obligations of a public official (the Secretary of State for Education) to establish the existence of certain facts before making a particular decision. Specifically, he had to satisfy himself that a local authority’s proposals were “unreasonable”. So far as relevant, it was found that the local authority had submitted a detailed letter to the Department of Education setting out comprehensively its reasons for its actions. Having reviewed the contents of that letter, the court found it difficult to conclude that the local authority was acting unreasonably (in the Wednesbury sense). The court’s decision hinged largely on the fact that the contents of the letter were likely to have been known within the Secretary’s department but were not taken into account at all in his decision. Lord Diplock (at [1065]) summarised the question for the court as;

“… did the Secretary of State ask himself the right question and take reasonable steps to acquaint himself with the relevant information to enable him to answer [the question] correctly”

The situation in the current case is not the same. HMRC attempted to establish the facts over a significant period of time but were given what transpires to have been entirely incorrect information. To expect it to then accept a very different version of events – the acceptance of which would require it to disregard inconsistencies (such as the entries in the first VAT Return and the corporation tax and accounting position of the companies in question) without explanation, is entirely different from the fact pattern in Tameside and the principle that can be derived from that case.

It is of course encumbent on HMRC to establish the correct facts before making decisions but in doing so it is reliant naturally on the taxpayer providing clear and correct information as to its affairs. That is the fundamental basis of the self-assessment system. SB did not do this and has not, as far as we can see, provided a rational explanation as to why that was the case.

It is not entirely surprising that Officer Mather made his initial decision based on what he had been told consistently for over two years – that version of events being backed up by what he pointed to as objective facts (the VAT Return, SB’s failure to account for output tax, the corporation tax position and the accounts of the companies).

This does not reflect well on SB’s trustees or its advisors.

Mr Nyoni in his further written submissions asked the Tribunal to take into account the Appellant’s inconsistency and failure to provide accurate information. Although he did not contend that deliberately false information was provided by SB, he suggested that the inconsistency and inaccuracy ought to have some bearing on the outcome of the appeal. Mr Nyomi also made the point that the facts presented by Mr Zwart were relatively new and if found true by the Tribunal, would describe a transaction which HMRC had not considered for VAT purposes.

We note HMRC’s frustration and the significant resources that it has expended in dealing with this matter.

However, notwithstanding the alternative versions of the facts presented by SB and its advisors, it is for the Tribunal to determine on the evidence before us whether or not SB made an exempt supply of land to its subsidiary as contended by HMRC. The facts on which SB’s appeal are based have been submitted to the Tribunal and shared with HMRC in accordance with the Tribunal Rules and the fact that HMRC has not fully considered the transaction that SB submits has taken place cannot be relevant to the Tribunal’s determination.

Mr Zwart submitted that SB made a supply directly to the Artists, that supply being of all of the components comprised in the Accelerator Programme. The supply of the studio rights was part of this, the entire supply being more than passive and involving instead an active exploitation of immovable property and so outside the exemption in Article 135(1)(l) of the PVD for the leasing or letting of immovable property.

Mr Zwart further submitted that SB did not make any supply of land to SIL and that the transaction that HMRC had identified as falling within the VAT exemption did not exist as a matter of law.

Mr Nyoni submitted that there was, in reality, a supply by SB to SIL of a licence to occupy land, with SIL then making a supply to the Artists. Mr Nyomi further submitted that the supply to SIL was a passive supply of land falling within the exemption at Article 135(1)(l) of the PVD.

To determine whether, as HMRC submit, there is a supply between SB and SIL which amounts to an exempt licence of land, a two-step approach is necessary.

This is clear from HMRC v Abbey National PLC [2006] EWCA 886.

In that case Abbey sought to reorganise and restructure its property portfolio through broadly, a series of sale and lease back arrangements (or for leasehold properties – sale and underlease arrangements) with a third party, Mapeley Columbus Ltd (“Mapeley”).

The terms on which it held some of its leasehold properties restricted assignment without landlord consent. To manage those restrictions Abbey entered into “virtual assignments” under which all the economic benefits and burdens of the leases in question would be transferred to Mapeley but without an actual assignment of the leasehold interests and with Abbey continuing to occupy the properties.

The Court had to decide whether, under the terms of the contractual arrangements between Abbey and Mapeley, the supply made by Mapeley to Abbey was an exempt supply being the “leasing or letting of immovable property” within the meaning of Article 13B of the Sixth Council Directive 77/388/EC of 17 May 1977 (the sixth directive). Article 13B is the predecessor to Article 135(1)(l) of the PVD. For our current purpose there is no material difference between the two provisions.

Having considered the authorities, Jonathan Parker LJ found that the issue had to be addressed in two stages:

“… The first stage is to analyse the nature and effect of the contractual arrangements between Abbey and Mapeley … . The second stage is to determine whether contractual arrangements of that nature and having that effect fall within Article 13B(b). The first stage is exclusively a matter of national law. The first stage is exclusively a matter of national law; the second, by definition, is exclusively a matter of Community law. [48]

It was common ground that the contractual arrangements between Abbey and Mapeley did not involve the transfer of any proprietary interest in the properties in question – whether in law or equity [50] nor did they transfer any contractual interest to occupy the properties. In short, as Mapeley had itself acquired no proprietary or contractual right to occupy the properties in question it was not in a position to lease back such a right to Abbey.

The Court reviewed several European authorities on the interpretation of the expression “leasing or letting” for Article 13B(b), with Jonathan Parker LJ concluding that

“… a right of occupation” was an essential element of a supply “of leasing or letting” within the meaning of Article 13B(b) – as Mapely had not acquired one it could not be in a position to transfer one back to Abbey and therefore the supply it made to Abbey could not be a supply of leasing or letting and so exempt – [86]

What this means is that for there to be an exempt supply of land between SB and SIL there must be a transfer of a right of occupation from SB to SIL.

HMRC’s argument hinges on SIL having acquired such a right from SB which it then passes on to the Artists under the terms of the Leases.

It is common ground that no written document providing for such an acquisition existed between SB and SIL.

Mr Zwart submitted that as no written document existed, no proprietary interest in the Building could have been transferred by SB to SIL. In support of that submission he cited s.2 of the Law of Property (Miscellaneous Provisions) Act 1989 which provides as follows:

“2(1) A contract for the sale or other disposition of an interest in land can only be made in writing and only by incorporating all the terms which the parties have expressly agreed in one document, or, where contracts are exchanged, in each.”

We agree with Mr Zwart. Although there are some exceptions to this provision, none seem applicable in the circumstances and Mr Nyoni did not contend otherwise. There can therefore have been no transfer of any proprietary interest in the Building from SB to SIL.

For HMRC to succeed there must therefore have been a contractual, non-proprietary right of occupation created in favour of SIL. Mr Nyoni made the point in this regard that a licence to occupy property did not need to be in writing – citing in this regard the following paragraph of HMRC’s guidance.

An HMRC manual is not of course a statement of the law, but we agree with Mr Nyoni that as a legal matter, a licence to occupy property may be a contractual right rather than a proprietorial interest in property and so does not need to be made in writing.

Mr Nyoni contended that the “commercial reality” of the situation was sufficient to indicate the existence of such a contract.

His contention was based primarily upon the following:

Mr Zwart submitted that HMRC’s submission could not be correct as SIL was established only after SB had started entering into the Leases. It was not, therefore, in existence at the time the supplies were made to the Artists. His point was that as a basic matter of law, a party that did not exist could not be party to a contract.

For SIL to be regarded as having acquired a licence to occupy the Building from SB and to have then made supplies to the Artists under the Leases would, at the very least, have required the initial Leases between SB and the Artists to have been amended to substitute SIL as landlord. However, it was not part of HMRC’s case that SB had changed its activities since entry into any of the Leases. HMRC also accepted that the initial Leases included in our evidence were representative of all the Leases in place with the Artists.

The only change that had been made to the Leases was for rental payments to be made to SIL rather than SB. We note also the evidence from Ms Fathi as an Artist, that all her dealings were with SB other than in relation to payment of rent. It was not open therefore for HMRC to argue that the Leases had been amended to substitute SIL as Landlord.

Mr Nyoni submitted that the fact that SIL had not been established at the time the initial Leases were entered into did not matter. He noted that SB’s agents had explained that Artists had been lined up in advance and contracts drawn up so that SIL’s activities “could start as soon as possible” - in other words the Leases entered into prior to SIL’s incorporation were entered into on the assumption that SIL would become party to them as soon as it was established. He noted also that the delay between the signing of the initial Leases and SIL’s establishment was short. Again, he referred to the commercial reality of the situation and the need for the VAT analysis to correspond to that reality.

He cited the FTT case of Hepburn [2013] TC 02837 as an example of a case “where a supply was found to be made by a company which was not incorporated at the time the supply was made”.

However, Hepburn does not in our view assist HMRC. That case concerned the provision of consultancy services by an individual who agreed to provide them via a company that she was yet to establish. The bulk of her services were performed before the company was formed. The question for the First Tier Tribunal to decide was whether the fee payable for those services should be taxed as income of the individual or the company once it was formed.

In that case the individual was prevented contractually from providing the relevant services in her own capacity hence the need to establish the company. It was also accepted by all involved that the company, once established, rather than the individual would be the service provider. Additionally a contract was drawn up stating that the consultancy services would be provided by “NewCo” which was described as a company that was to be incorporated if fees were found to be chargeable. Finally, under GAAP, the invoiced amounts were allocable to the company and it was agreed by the FTT that the individual would never have been entitled to the income nor did she actually receive it. The FTT found that in the circumstances the income was taxable in the hands of the company and not the individual. The decision was a direct tax decision based on a very specific set of facts and concerned ultimately with the allocation of income. The decision did not establish the existence of contractual relationships nor the existence of a supply for VAT purposes.

Given the entry by SB into Leases with the Artists prior to SIL being formed, and there having been no change to those Leases or SB’s activities since SIL was incorporated, it is difficult to identify a sustainable basis on which a contract between SB and SIL conferring a right of occupation which SIL then passes on under those Leases can be identified. It seems to us that contractually SB has already passed on that right to the Artists.

We note that HMRC’s position is based on its perception of the commercial situation and the facts as presented to it by SB and its agents up to August 2021.

However, a commercial perception together with statements made by a taxpayer (and subsequently contradicted) are not a sufficient basis on which to identify the existence of a supply for VAT purposes. That is because the starting point relies, ultimately, on the legal relationships that exist. The VAT position may differ in the case of sham or abuse – but neither of those circumstances have been raised by HMRC in this case.

For the reasons given we find, therefore, that SIL did not acquire from SB a contractual right to occupy the Building.

We find accordingly that there can have been no exempt supply between SB and SIL of land within the scope of Article 135(1)(I of the PVD nor within the scope of Item 1, Group 1 Schedule 9 VATA as no such supply took place.

It follows that the disallowance of SB’s input VAT claim and HMRC’s best judgement assessment cannot be valid as those decisions take into account a supply that did not take place.

Mr Zwart’s core submission was that SB made a direct supply to the Artists pursuant to the terms of the Leases which supply did not amount to the “leasing or letting of immovable property” and so was not exempt under Article 135(1)(l) of the PVD.

Mr Zwart cited several authorities in support of his proposition, the main one being Stichten “Goed Wonen” v Staatssecretatis van Financien [2001] 3 CMLR 54 (“Goed Wonen”) from which he cited the following paragraphs:

“Although the leasing of immovable property is in principle covered by the concept of economic activity …, it is normally a relatively passive activity, not generating any significant added value, Like sales of new buildings following their first supply to a final consumer, which marks the end of the production process, the leasing of immovable property must therefore in principle be exempt from taxation …” [52]

“However, it is also consistent with the general aim of the Sixth Directive that if immovable property is made available to a taxable person through leasing or letting, as a means of contributing to the production of goods or services whose cost is passed on their price, the property stays within, or returns to, the economic circuit and must be capable of giving rise to taxable transactions. The common characteristic of the transactions within Article 13B(b) of the Sixth directive excludes from the scope of the exemption if indeed they involve the more active exploitation of immovable property.”

Mr Zwart’s submission was, in essence, that (a) the supply made by SB to the Artists under the Leases was of the entire Accelerator Programme of which the studio rental was only a part, and (b) the components of that Programme were inseparable and as a whole involved more than the passive exploitation of land.

As HMRC’s focus was on identifying the purported supply from SB to SIL of a licence to occupy the Building, its challenge to Mr Zwart’s submission on the nature of the supply made by SB to the Artists centred on its position that the supply was made by SIL and not SB.

Officer Mathers acknowledged, however, that if there was in fact such a supply it would in his opinion amount to more than a passive supply of land.

Having considered the evidence presented, we find, on the balance of probabilities, that there was a supply from SB direct to the Artists under the Leases.

Factors that have assisted us in making this determination include (together with those mentioned already in relation to the purported supply between SB and SIL) the following:

We also find that the supply involved more than the passive exploitation of land. This is on the basis that the supply under the Leases (the terms of which included the Studio Obligations) was essentially of the Accelerator Programme of which the studio rental was, although a central element, one element only – with all elements being inseparable. The supply was not therefore an exempt supply within Article 135(1)(l) of the PVD or Item 1, Group 1, Schedule 9 VATA.

Although we have concluded that the supply was not an exempt supply of land we make no further findings in respect of it. We note however that there are questions in relation to its commerciality given that it is not, from the evidence provided by Ms Verkade and the submissions made by Mr Zwart, intended to generate funds sufficient to cover the costs of the programme.

For the reasons given we find that SB did not make an exempt supply of land to SIL and therefore HMRC’s decision to deny input tax recovery and its best judgment assessment cannot be valid as those decisions reflect a supply that was not actually made. The Appeal is accordingly allowed.

This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. The application must be received by this Tribunal not later than 56 days after this decision is sent to that party. The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.