For VAT purposes a ‘business’ can be a business conducted from the premises in question and also the ‘rental business’ conducted by a landlord by its letting of premises. Atransfer of such a business (or a separate functioning part of it) may be a ‘transfer of a going concern’ (TOGC). From that a number of VAT consequences flow:

(1) The transfer of assets comprised in the business will not be treated as a ‘supply’ for VAT purposes. This means that even though the transfer might be a sale, the transferor does not have to account for VAT on the sale price. Where the assets transferred include land (freehold or existing leases), great care is needed to comply with the conditions for TOGC treatment that may require the transferee to elect to waive exemption from VAT (‘opt to tax’) before the transfer takes place or any payment of the price (other than a deposit paid to a stakeholder) is made.

(2) The transferor’s turnover in the period of one year preceding the date of transfer will be attributed to the transferee for the purposes of determining whether the transferee is liable to be registered for VAT, if it is not already registered or otherwise liable to be registered.

(3) Responsibility for the preservation of VAT records of the business relating to periods before the transfer may pass to the transferee.

(4) Responsibility for VAT adjustments under the ‘capital goods scheme’ will pass to the transferee.

(5) If the transferee takes over the transferor’s VAT registration number, the transferee effectively stands in the shoes of the transferor for VAT accounting (including payment of outstanding tax) referable to periods before the transfer.

Compliance with VAT law is secured by a range of financial penalties – interest on overdue tax and fines for administrative failures. HMRC, which administers the VAT system, is not noted for a light-touch approach.

Where parties to a business transfer are professionally advised, the transfer transaction will be properly scrutinised, appropriate due diligence performed, and the business transfer agreement will contain provisions that respond to the particular circumstances and allocate risks accordingly. The parties will be properly advised on their individual VAT compliance obligations and in cases of particular difficulty, guidance can be sought from HMRC. In addition, HMRC’s VAT Notice 700/9 provides a very useful explanation of the basic rules and is available on its website.

The recent case of MPH Leisure Ltd v HMRC [2006] shows us that spotting a potential TOGC is not always easy.

MPH Leisure

The facts

Mr and Mrs Iredale ran a licensed private members club, known as ‘Val’s Priory Club’, from premises in Redcar. They were registered for VAT. The club sold alcohol and provided events, such as bingo sessions, in an upstairs function room.

MPH had had negotiations with the Iredales with a view to purchasing the club eventually, taking an interim 12-month lease in the meantime. But before that deal was consummated, the Iredales sold the club to someone else. MPH’s feelings about that are not recorded but, undaunted, it approached the new owners (before the sale was completed) and entered into negotiations, which resulted in the new owners granting MPH a ten-year lease of the club premises on the day after completion of the sale.

The lease required MPH to carry on the club business and to buy its drinks stocks from the landlord’s suppliers. MPH engaged around ten of the staff previously employed by the Iredales.

MPH applied to be registered for VAT three months after taking the lease. In its application form the company declared that it had taken the club over as a going concern from the Iredales and quoted their VAT registration number.

Four months later, however, MPH’s representative wrote to HMRC saying the application was mistaken. MPH had not taken over a going concern from the Iredales and should be registered not from the date of the lease, but three months later.

HMRC maintained MPH’s date of registration from the date of the grant of the lease, and assessed it for VAT due on sales during the three-month period. MPH appealed to the VAT Tribunal against both decisions.

The issues

The issues were straightforward – if MPH took over the Iredales’ business as a going concern, the earlier date of registration and liability for VAT as assessed by HMRC was correct. If not, the later date and commencement of liability were.

HMRC argued that TOGC legislation did not require the transferee to purchase the business from the outgoing owners or to acquire assets employed in the business. It was enough that, in substance, a person is put in possession of a business as a going concern with no interruption in trading.

MPH, on the other hand, argued that it was not party to a transfer of the business from the Iredales (as they had sold it to MPH’s landlord) and MPH had acquired it from the landlord under the lease. Since the landlord has not carried on the business, MPH did not acquire it as a going concern from the landlord.

The decision

The Tribunal upheld HMRC’s view. The concept of ‘transfer’ implicit in the TOGC legislation did not require a precise analysis of the legal steps by which a successor acquired a business, or from whom. It was enough that the combination of transactions between the Iredales, the new owner and MPH had the overall effect of putting MPH in possession of the Iredales’ business and it was not necessary, for TOGC purposes, for the ‘transfer’ to be effected in a single transaction between transferor and transferee, legally effected by assignment of the component assets of the business.

Comment

The crucial point to recognise is that there does not have to be a transfer of assets as such in order for there to be a transfer of a ‘business’ for TOGC purposes. The concept of ‘business’ is separate from the component assets within it.

Where assets are transferred, then that will be a significant indicator of a TOGC – but not conclusive.

It is, however, somewhat difficult to reconcile the MPH decision with HMRC’s view, expressed in its VAT Notice 700/9 (Transfer of business as a going concern) that ‘immediately consecutive transfers of the business’ (for example, where there is a sub-sale of the business) cannot be a TOGC. It says this is the case because the intermediate transferor does not itself carry on the business. This seems at odds with the test applied in MPH – was the substance of the arrangements such as to put the ultimate transferee in possession of a predecessor’s business? There seems no good reason why this should be any less the case where the business may have been acquired under a sub-sale than under the transactions that occurred in MPH.

Davey v Lombard Asset Management

In the second case, Davey v Lombard Asset Management (Bahamas) Ltd [2006], the parties to a sale and purchase transaction were fully aware that it might constitute a TOGC – the problem was construing the contractual provisions they had used to cover that possibility.

The facts

The parties contracted for the sale and purchase of let property (being a ‘rental business’ carried on by the seller). In the contract, they adopted a relatively common form clause to cover the TOGC possibility, which included the following:

… the buyer… shall, upon completion, warrant that it is registered for the purposes of Value Added Tax and it has elected to waive exemption of the VAT in respect of the Property and has notified HM Customs and Excise on such election…

From this it can be deduced that the seller was registered for VAT and had itself elected to waive exemption from VAT in respect of the property. The purpose of the ‘warranty’ was to ensure that the circumstances of the buyer were such as to ensure TOGC treatment. Come the contractual completion date, however, the buyer had applied to be registered, but actual registration had not been effected.

By agreement between the parties, completion was delayed (presumably until the buyer in fact became registered).

The issues

Was the seller entitled to hold that the buyer was ‘in default’ under the terms of the contract so as to be liable for compensation to the seller for the delay in completion?

The agreement between the parties to delay completion did not deal with this question, so it fell to the court to decide. The buyer argued that the ‘default’ provisions of the contract did not apply because:

(1) the provision which appeared on its face to be a ‘warranty’ as to its VAT registration was not a condition of the contract – it was merely a warranty in the strict sense;

(2) an associated provision in the contract required the buyer to pay VAT on the purchase if the transaction was not a TOGC, so the seller would not have sustained any loss by the breach of the warranty; and

(3) the seller had acquiesced in the delay in completion, so the delay was consensual and not a default by the buyer.

The court had no time for the first point. Although expressed as a ‘warranty’, the parties clearly intended that the buyer should be actually registered for VAT at the time of completion. The ‘warranty’ was a condition of the contract that the buyer was implicitly obliged to fulfil – and failure to do so put it in default.

In light of that, the second and third points fell as well.

Comment

Three lessons can be learnt from this:

(1) It is not helpful to express as a ‘warranty’ (or a representation) something that is intended to be a condition of a contract that one or other of the parties is actually obliged to fulfil.

(2) When agreeing a delay in completion, ensure that the agreement covers all consequences of the delay.

(3) Consider carefully the drafting of VAT TOGC conditions in the contract – this one required the buyer to be ‘registered’. In fact, the VAT law requirement is that the buyer is already a ‘taxable person’ (which means someone who is or is liable to be registered for VAT) or becomes a taxable person as a result of the transfer. Often, it is not actually necessary for the buyer to be fully registered at the time of the transfer for TOGC treatment to apply. Admittedly, the seller obtains greater certainty that the transaction will be a TOGC if the buyer proves that it is registered, but absence of registration is not always fatal to TOGC treatment, and delays in securing actual registration are, unfortunately, quite common. If the deadline for completion arises before registration is effected, consider whether the buyer’s circumstances qualify it anyway.  © Property Law Journal