20712

Value added tax – input tax – Registered social landlord transfers its development project to a wholly-owned subsidiary – Whether able to reclaim input tax in respect of professional services commissioned before transfer – Regulation 109 VAT Regulations 1995 – Whether change of intention – No

LONDON TRIBUNAL CENTRE

	COMMUNITY HOUSING ASSOCIATION LTD	           Appellant

-	and –

	THE COMMISSIONERS FOR HER MAJESTY’S REVENUE & CUSTOMS 	 Respondents

				Tribunal:	MISS J C GORT (Chairman)
						MRS R YOUNG

Sitting in public in London on 1 May 2008

Mr Phillip Henwood, VAT consultant, for the Appellant

Mr S Singh of counsel, instructed by the solicitor’s office, for the Respondents

© CROWN COPYRIGHT 2008

DECISION

1.	This is an appeal against a decision of the Respondents dated 3 May 2007 not to accept the Community Housing Association Ltd’s (“CHA”) voluntary disclosure in the sum of £458,448.  This disclosure was in respect of input tax that had previously been allocated to exempt activities and which CHA sought to reclaim under Regulation 109 of the Value Added Tax Regulations 1995.  The grounds of appeal are that CHA “originally blocked input VAT recovery on supplies of services received by it because of an intention to make exempt supplies.  Before the services were used CHA onwards supplied them plus VAT.  Because of change of intention CHA reclaimed the VAT but HMRC rejected the reclaim.”

The Background
2.	CHA is a limited company incorporated under the Friendly and Industrial Provident Societies Act 1968.  It operates from premises situated at 100 Chalk Farm Road, London NW1 8EH.  It is a registered social landlord and is engaged in the provision of accommodation to needy persons.  

3.	Part of CHA’s business involves acquiring new sites upon which dwellings are to be built. When CHA acquires a new site ordinarily it appoints contractors to undertake the design and construction work on the site.  

4.	On 27 July 2006 CHA wrote to HMRC advising of a VAT reclaim of £276,818.90 in relation to a number of construction projects, namely:  Fortress Road, Grays Inn Road, Green Road, 238 Kingsland Road, 479 Kingsland Road, Laycock Street, Spring Place and St Annes/Bouverie.  Two more development projects, at Brooke Road and Caledonian Road, which brought the total reclaim to £458,428.15, were added by CHA by an e-mail sent to HMRC dated 16 January 2007.

The law
5.	Regulation 109 of the Value Added Tax Regulations 1995 provides that:
(1)	This regulation applies where a taxable person has incurred an amount of input tax which has not been attributed to taxable supplies because he intended to use the goods or services in making either – 

(a)	exempt supplies, or
(b)	both taxable and exempt supplies,

and during a period of six years commencing on the first day of the prescribed accounting period in which the attribution was determined and before that intention is fulfilled, he uses or forms an intention to use the goods or services concerned in making taxable supplies or, in the case of an attribution within sub-paragraph (a) above, in making both taxable and exempt supplies.  

(2)	Subject to regulation 110 and where this regulation applies, the Commissioners shall, on receipt of an application made by the taxable person in such form and manner and containing such particulars as they may direct, pay to him an amount equal to the input tax which has become attributable to taxable supplies in accordance with the method which he was required to use when the input tax was first attributed.

(3)	For the purposes of this regulation any question as to the nature of any supply shall be determined in accordance with the provisions of the Act and any regulations or orders made thereunder in force at the time when the input tax was first attributed.

The facts
6.	The Tribunal heard evidence from Mr Michael Graham Brookes, who is the Assistant Director of Development and Head of Construction at One Housing Group, which is the holding company of CHA, on behalf of CHA.  A witness statement from a Mr Mark Anthony London, a solicitor and partner of Devonshires Solicitors, was not objected to by the Respondents and was read by the Tribunal.  An agreed bundle of documents was produced.

7.	Prior to 1 February 2006, CHA had dealt with all developments internally, procuring the necessary professional services to construct new dwellings itself.  

8.	CHA is a limited company incorporated under the Friendly and Industrial and Provident Society’s Act 1968 and is registered as a social landlord with the Housing Corporation in England, which is also its regulatory body.  

9.	In the latter part of 2005 CHA conducted a periodic review of its business, this review being brought about, inter alia, by the need to increase efficiency in its operations in terms of the Gershon Efficiency Review of 2003, which dealt with public bodies.

10.	One of the major areas of expenditure of CHA was the procurement of new housing.  At the time of the review in 2005 the CHA Board of Directors (“the Board”) felt that its growing development function was becoming a distraction from its core business of providing social housing for the neediest members of society, particularly given that the Board lacked expertise in development matters.  The system which was in operation did not enable CHA to recover VAT on construction costs which were incurred when it retained the buildings to add to its rental stock. Where CHA incurred VAT on the construction of new dwellings, this could only be recovered where the subsequent first use of the finished dwellings by CHA was either sold to a third party or to another registered social landlord, or sold to a tenant via shared ownership.  Given that normally the majority of new dwellings are likely to be retained to add to the general needs of rental stock, giving rise to exempt income, this resulted in CHA being at a disadvantage as against other housing providers, who are able to recover the VAT incurred on professional fees upon the subsequent zero-rated first sale.  

11.	Traditionally registered social landlords have sought to mitigate this irrecoverable VAT by entering into design and build contracts from property developers, thereby the developers have procured professional services and provided a composite zero-rate supply of new dwellings under Item 2(a), of Group 5 to Schedule 8 of the VAT Act 1994.  CHA did not choose this route because not all builders or developers would enter into this type of arrangement.  Even when they were willing to do so, not all services, for example the services of a managing agent, could be incorporated.  Furthermore CHA did not wish to relinquish control of design quality and budget as is necessary in that type of arrangement.  Additionally, the building developers would often choose their own preferred service providers and add their own mark-up onto these, again raising issues of quality, control and price.  This meant that even where the structure was adopted, there was still a significant amount of irrecoverable VAT.

12.	For the above reasons CHA decided to set up a new development company, CHA Ventures, which was a wholly-owned subsidiary of CHA.  CHA Ventures thenceforth undertook all future development activity.  It acted as a property developer, and provided a zero-rated supply of design and build services to CHA, which enabled full associated input VAT recovery by CHA Ventures.  This scheme is accepted by HMRC.  

13.	Those projects which were under way as at 1 February 2006 but not yet completed, were transferred to CHA Ventures.  These projects, which CHA had originally commissioned, were assigned in their entirety to CHA Ventures.  This enabled CHA to concentrate on its core business of providing high quality social housing.  

14.	At about the same time as CHA was considering implementing a new structure, European Union procurement rules meant that it was obliged to open all its large scale procurement to competitive tender and to choose a panel of preferred bidders for all future work.  It was therefore decided to give CHA Ventures the sole right to appoint construction contractors for EU procurement purposes, and henceforth CHA would have no legal right to enter into construction contracts in its own name.  This change was effective from the beginning of February 2006, and all suppliers were notified that all existing contracts were to be assigned and future work would be provided to CHA Ventures.  Having transferred its development function to CHA Ventures, CHA no longer had the capability to proceed with the development.  All future invoices were addressed to CHA Ventures, but additionally it was considered that CHA could only take over development already under way if it was given the benefit of the services such as those of architects and surveyors.  In January 2006 therefore CHA had advised its contractors that such works would be re-invoiced to CHA Ventures.  

15.	It was Mr Brookes’ evidence that the single most important reason for re-invoicing the value of works previously contracted for by CHA to CHA Ventures where projects were under way but not yet completed, was to ensure the effectiveness of the existing collateral warranties. Collateral warranties are designed to establish unequivocal ownership of projects and thereby increase the chances of mounting successful claims for damages in the event of major construction defects. This was considered to be essential for CHA as a constructing registered social landlord. The collateral warranty is a separate contract which sits beside the main building contract, and in the event that the main contractor becomes insolvent and there is a building defect, the client uses the collateral warranty to sue the specialist sub-contractors and consultants to recover damages.  In evidence Mr Brookes stated: “CHA Ventures is the client named in the contract.  It must be able to demonstrate that it has been the client for the duration of the contract and the most effective way of doing this is for CHA to invoice costs to CHA Ventures.  This reduces the ambiguity of CHA Ventures’ position on projects assigned by CHA when CHA Ventures has to take legal action for damages for a major building defect where the breach takes place before 1 February 2006.”  It was his opinion that, in the event of faulty work completed on behalf of CHA, CHA Ventures would be able to sue.  This is in our view a mistaken belief.

16.	Mr London’s evidence was simply to the effect that it was his opinion that warranties within the construction industry were absolutely essential. The warranties give an employer a direct contractual right to bring a claim against the consultant or sub-contractor that has caused a failure.  Any construction professional who advised his client that warranties were not required ran a real risk of being found negligent in the event that the contractor is unable to satisfy any judgment or award arising from a failure in the works.

17.	The contract between CHA and CHA Ventures Ltd is dated 13 March 2006 and in it CHA is called the “owner” and CHA Ventures Ltd is called the “developer”.  It provides in part as follows:

3.	BUILDING CONTRACT

3.1	The Developer will procure that the Building Contractor and each sub-contractor having a material design responsibility enters into a Collateral Warranty in favour of the Owner the Owner’s Funder and any person or body that may be providing finance for the Development and any tenant of the Development in the form annexed hereto prior to the Practical Completion Date.  

3.2	The Developer will use all reasonable endeavours to procure that the Building Contractor performs and observe the terms of the Building Contract.  The Developer agrees not to vary, waive or release any of the terms of the Building Contract without the Owner’s consent.

4.	PROFESSIONAL TEAM

4.1	The Developer will procure that each member of the Professional Team enters into a Collateral Warranty in favour of the Owner and any other person or body that may be providing finance for the Development and any tenant of the Development in the form annexed hereto prior to the Practical Completion Date.

4.2	The Developer will use all reasonable endeavours to procure that each member of the Professional Team performs and observe its terms of appointment.  The Developer agrees not to vary, waive or release any member of the Professional Teams’ terms of appointment without the Owners’ consent.

18.	It will be seen from this document that CHA remains a beneficiary of the warranties both after February 2006 as well as before.

19.	The collateral warranty form is headed: “Collateral warranty to be given by the consultant in favour of a third party taking the whole or part of the client’s interest.”  In this case the beneficiary is CHA, the client is CHA Ventures Ltd and the consultant is the supplier.  The preamble reads:

“WHEREAS:- 

(A)	The Client is undertaking […] (the “Project”).
(B)	The Beneficiary has entered or will enter into an agreement (the “Agreement”) with the Client for the acquisition of an interest in all or any number of the properties forming part of the Project.
(C)	The Client has entered into a consultant framework agreement dated […] (the “Consultant Framework”) with the Consultant for the provision of specialist consultancy services (the “Services”) as and when required.
…

2.	CONSULTANTS’ WARRANTIES

2.1	The Consultant hereby warrants to the Beneficiary … 
2.2	The Consultant shall have no greater liability to the Beneficiary under this Deed than the Consultant would have had if the Beneficiary had appointed the Consultant and be named as the “Client” in the Consultant Framework …”

	14.	Actions and proceedings 

14.1	The Developer would diligently pursue any actions or proceedings required by the Owner and agreed by the Developer as being commercially prudent and reasonable against the Building Contractor or a member of the Professional Team in order to enforce the performance of their respective obligations.

14.2	The Developer will apply any sums recovered as a result of such actions or proceedings in remedying the situation that gave rise to the actions or proceedings.

14.3	The Developer will take account of any proper and reasonable request or proposals made by the Owner in relation to the conduct in any such actions or proceedings.

The Appellant’s case
20.	It was submitted by Mr Henwood that the ability to recover input VAT depends on the use to which the input is put, and in this case CHA had initially restricted VAT recovery on the basis that its services would go towards the construction of general needs housing which would generate exempt rental income.  Prior to the buildings being completed, and CHA having an opportunity to put the building to use, it had changed its intention in that instead of completing the buildings itself, it would employ the development services of CHA Ventures.  It was CHA’s case that it made an onwards VATable supply of the services to-date to CHA Ventures, which gave rise to an entitlement to input VAT recovery.  

21.	It was submitted on behalf of CHA that it was illogical and unfair to accept the supply between CHA and CHA Ventures without accepting the right to related input VAT recovery, there being a valid change of intention prior to first use and re-supply of services from CHA to CHA Ventures.  

22.	It was not accepted on behalf of CHA that its sole purpose was to achieve a saving of VAT; there were important business reasons behind the adoption of the new structure: (i) it enabled an on-going saving to be made in new procurements thereby complying with the Gershon Efficiency Review, (ii) it enabled CHA to remain cost-competitive when tendering for new development budget as against other registered social landlords which had already adopted a similar structure, (iii) it enabled CHA Ventures to offer its services to other registered social landlords, such as Toynbee (with which CHA had now formed an association) and thereby to achieve economies of scale, and, finally (iv) it allowed the Board to focus on its main purpose of providing social housing.  It was considered that CHA Ventures alone would be the single point of contact for any defective workmanship and would be the single party to approach all contractors.  Uncertainty in relation to collateral warranties would have prevented CHA Ventures from stepping into the shoes of CHA with regard to on-going developments without the benefit of these being formally transferred to CHA Ventures.  

23.	It had been necessary to give CHA Ventures the benefit of the significant amount of work already commissioned by CHA as CHA Ventures would be responsible for completing the construction.  It was only by re-invoicing CHA Ventures that it could step into the shoes of CHA and assume the benefit of the various collateral warranties that it would need to be able to rely on in the future.  Thus CHA became a service supplier to CHA Ventures.  This constituted the required change of intention by CHA within the terms of regulation 109. 

24.	Mr Henwood pointed to the Respondents’ understanding that CHA had commissioned the works in its business activity as a social housing developer, however it was not CHA’s business to build new dwellings, this was simply an alternative method of procurement in relation to its business which was the provision of high quality social housing.  At the time that CHA paid for the professional services, the buildings were incomplete and unavailable for use in its business.  At the time it commissioned the building works, it was procuring new dwellings to add to its portfolio. By re-selling the services to CHA Ventures, CHA had made a taxable supply and it had changed its intention with regard to the incidental development expenditure.  It is always open to a taxable person to change intention prior to first use, which is specifically recognised by regulation 109.  Had CHA completed the building itself, it could always have changed the eventual first use.  

25.	HMRC normally expect a registered social landlord to repay input tax previously recovered on the basis of an intention to make future zero-rated supplies, for example if the proportion of buildings were outright sale of shared ownership decreased prior to such use.  It was submitted that the taxable first use cannot occur before the buildings received a certificate of practical completion and were first made available for occupation, until this time, the taxpayer must continue to monitor its intended use of the building. Changes in intention may give rise to an ability to recover or an obligation to repay VAT.  In relation to the site known as Kings Cross Goods Yard CHA had acquired the site plus VAT with the intention of developing it for new offices.  After site acquisition but before the new offices were built, CHA had changed its plans and henceforth the land was to be used for exempt general needs housing.  Accordingly regulation 109 required CHA to re-visit its initial VAT recovery and to repay HMRC the input tax that it had previously recovered.

26.	In relation to the case Pierhead Housing Association (VAT Decision 18713) which was relied on by the Respondents, it was submitted that it should be distinguished on its facts. In that case architect’s services had been supplied to a registered trader who was making exempt supplies, and there was subsequently a novation of the architect’s agreements to the builder.  The question was whether the trader was making a taxable supply of the architect’s services to the builder and whether the input tax on the architect’s fee was recoverable.  The appeal was dismissed.  CHA relied on the fact that in the present case all matters were assigned to CHA Ventures Ltd and at no stage were the contracts novated.  This meant that the original input tax was always proper to CHA, and as a recipient of the services CHA was fully entitled to resell them to CHA Ventures.  Furthermore in Pierhead there was never actually a recharge of costs, in the present case, although being fully aware of the fact of the recharge from CHA to CHA Ventures, the Commissioners had never objected to the VAT treatment of the recharge invoices or recovery of the related input tax by CHA Ventures, thereby implicitly confirming the supply.

The Respondents’ case
27.	It was the Commissioners’ case that in respect of the professional services incurred prior to 1 February 2006 there was no new supply.  Prior to that date the input tax had been restricted because the Appellant intended to use the professional services provided to it to make an exempt supply.  When CHA Ventures was set up it became liable for the cost of the services which had been provided to CHA.  This was not in itself a new taxable supply and the commercial reality was that there were no further supply. 

28.	Even if there were a supply, it was the Commissioners’ case that the supply did not alter the purposes for which the costs payable by CHA, and then by CHA Ventures, were incurred, as the intention remained that CHA would use the buildings created to generate exempt rental.  Shifting of the costs liability from CHA to CHA Ventures did not change how the supplies of the professional services were ultimately used by the Appellant.  CHA made no new supply, there was not, as CHA had maintained a re-supply of standard-rated professional services.  Because CHA did not supply anything to CHA Ventures Ltd, the question of whether the supplies were taxable or exempt was an academic one, and regulation 109 was not relevant.  There was never any change of intention on the part of CHA.  

29.	With regard to CHA’s argument that it had been necessary to transfer the value of the work done to CHA Ventures in order to improve certainty over collateral warranty issues, it was submitted that this argument was illogical.  As a matter of straightforward contract law, CHA Ventures would not be able to enforce any warranty which CHA had taken out, it would be CHA which would have looked to a collateral warranty in the event of poor workmanship, not CHA Ventures.  Mr Singh could not see how a company in the position of CHA Ventures could have needed any sort of collateral warranty for the work done on a site before it had even been incorporated and registered.  

30.	Clauses 3 and 4 of the development agreement between CHA and CHA Ventures Ltd indicated that CHA was still in the picture and clauses 14.1 and 14.2 protected CHA. CHA therefore continued to have a substantive interest in each site.  The effect of introducing CHA Ventures made reliance on a collateral warranty more cumbersome, in that in the event of sub-standard workmanship it necessitated CHA contacting CHA Ventures who would then contact the offending sub-contractor, whereas prior to the introduction of CHA Ventures, the Appellant was able to go directly to the sub-contractor to enforce the collateral warranty in the event of poor quality work.  In any event the collateral warranty could have been assigned from CHA to CHA Ventures Ltd without the need retrospectively to transfer the liability for costs incurred for professional services from CHA to CHA Ventures.

31.	The Commissioners relied on the case of Pierhead Housing Associations Ltd (supra).  In that case the tribunal had observed that the idea that there was a transfer of a supply was contrary to the reality of what had happened.  

32.	It had originally been submitted on behalf of the Commissioners that Caledonian Road Playground fell outwith the provisions of regulation 109 of the VAT Regulations 1005 because the provision of a playground without fees being charged was a non-business activity.  It was recognised by the Commissioners that there was no provision of a playground in respect of that site, it simply being the name for one of the housing developments.  

Reasons for decision
33.	Regulation 109 requires that a person seeking to benefit from it change a previous intention to make either exempt supplies, or to make both taxable and exempt supplies, to an intention to use the relevant goods and services in the making of taxable supplies, or, where previously he has been making only exempt supplies, to make both taxable and exempt supplies.  CHA appear to have misunderstood this wording, and thought that by transferring the obligation to pay for the supplies to CHA Ventures, they had changed the nature of the supplies themselves.  This is not the case.  The supply was still one of architectural and professional services in respect of either exempt supplies or, as the evidence shows in some cases, the supply of both taxable and exempt supplies.  We accept the Commissioners’ arguments and find that there was no change of intention with regard to the supplies.

34.	It is completely irrelevant that CHA felt the need to transfer the collateral warranties.  Even if CHA had by so doing achieved what it was put to the Tribunal that it was attempting to do, it would still be irrelevant.  The input tax relates to the supply by various professionals to CHA in respect of exempt or, possibly, partially exempt transactions, but at no stage was the nature of those supplies changed by CHA’s actions.  As was submitted by Mr Singh, it would still fall to CHA to enforce the collateral warranty, it being made between CHA and the respective contracting party.  Any benefit of such enforcement would then be passed to CHA Ventures.

35.	This appeal is dismissed.  There is no order for costs.

MISS J C GORT
CHAIRMAN

RELEASED: 10 June 2008

LON 2007/0940