Bell & Scott

Bell & Scott Property Update, July 2006

Welcome to the July 2006 issue of Bell & Scott Property Update.

In this month's issue we comment on the third decision in the Marcus Dean trilogy demonstrating possible dangers in irritating a lease without due consideration of the potential consequences and look at a recent English case in which a seller elected to waive exemption to VAT after the sale of the property to the detriment of the purchaser.

In the June 2005 Edition of Property Update we commented on two decisions arising out of the case of Marcus Dean trading as Abbey Mill Business Centre v Tony Russell Freeman. The result of those decisions was that the landlord (Mr Dean) was unable to undo a decision to irritate (forfeit) the leases of 15 Units at a business centre in Paisley.

A third decision has now been issued in respect of a dispute relating to lease obligations to carry out repairs. As with the earlier cases, Mr Dean sought to pursue the tenant’s guarantor. The relevant clause contained two elements; in the first place there was an obligation on the tenant to maintain the premises (including landlords’ fixtures and fittings) in good and substantial condition throughout the currency of the lease and secondly there was an obligation on the tenant to redecorate before vacating the property.

As the lease had been irritated, the tenant could not be compelled to perform the obligations it was bound to perform at the natural end of the lease. Mr Dean thus could not pursue a claim against the guarantor (Mr Freeman) in respect of the end of lease redecoration obligations. Mr Freeman could only be liable, at most, for the failure to comply with maintenance obligations during the currency of the lease.

Mr Dean argued that the cost of redecoration was recoverable because affixing objects to the walls marked them and instantly created an obligation to redecorate. He also argued that carpeting needed replacement as it was universally worn. Finally, he argued that Mr Freeman was liable for the costs incurred as a result of the liquidator’s failure to remove the tenant’s property after vacating the premises (as was necessary before the carpets could be removed and replaced).

Lord Eassie rejected much of these arguments. He found that the suggestion that there was a redecoration obligation based on the “damage” done by fixing things on walls would imply there was a prohibition on hanging anything on the walls and that that would have been a highly unusual restriction which would have been expressly imposed had it been intended. He held that where carpets had been supplied by the tenant, as was the case for many of the units leased, replacement was not something for which the landlord could claim. The claim could only succeed as far as it related to the units where carpets had been supplied by Mr Dean. As the claim for removal of the tenant’s property had been ancillary to the claim for replacement of the carpets, that could only succeed in respect of those units where the carpets had been supplied by the landlords.

However, the sums which could be recovered amounted to less than the deposit paid by the tenant at the beginning of the lease and therefore could simply be deducted from the deposit leaving no claim against Mr Freeman.

The dangers of acting without careful consideration of the consequences continue to be made very clear by this ongoing saga. Mr Dean was perfectly entitled to terminate the lease as he did, but it is apparent that the effect of that, in relation both to his ability to pursue future rent from the guarantor and to pursue repair costs which would otherwise have been recoverable under the lease, was not fully considered before serving the notice.

It seems clear beyond doubt that irritating a lease will limit what a landlord can claim on repairs, which is a factor to be considered before that irritancy letter is issued.

What is also interesting from the judgement is the clear distinction between what can be recovered as a cost of breaching the lease, and the costs the landlord actually incurs in preparing a property for new tenants. Some of the costs claimed by Mr Dean related to the costs of redecoration in “neutral” colours. The court made it clear that whilst it was entirely understandable that a new tenant may prefer that and it may be a necessary cost of reletting, it does not follow that it is a cost chargeable to the tenant – the issue is whether the cost arises from the breach of the lease.

Marcus Dean trading as Abbey Mill Business Centre v Tony Russell Freeman (No.3)

The full text of the decisions is available from the Scottish Courts Website here.

Electing to waive retrospectively

Purchaser surprised by Seller’s election to waive exemption to VAT after sale

In a recent case involving the sale of a property in Peterborough, the Seller (Net Support) elected to waive exemption but failed to notify HM Revenue & Customs (HMRC) of that election until after property had been sold. When the HMRC accepted the election, the Purchaser (Marlow Gardner), which was a pension company and not registered for VAT, sought to challenge the seller's election on the basis that it had been an invalid election and that the notification operated retrospectively.

Net Support had purchased the property in September 1998 and let part of the property to an associated company in October 1998 at which point it took the decision to charge VAT on the rent.

In terms of the VAT legislation, Net Support was entitled to elect to bring the property into the VAT taxation regime, however, once it had done so, it was obliged to charge VAT on the sale of the property. The legislation provides that, in order to bring the property into the VAT regime, it is necessary firstly to make an election to waive exemption and secondly to notify HMRC of that election.

The VAT Tribunal held that the election had been made on the charging of VAT in October 1998. Net Support sold the property to Marlow Gardner in January 2004 and in February 2004, Net Support wrote a letter to HMRC which seemed to have been accepted by HMRC as an effective late notification of the election to waive VAT.

The High Court Judge rejected Marlow Gardner’s contention that the VAT Tribunal’s decision was wrong in law pointing out that the legislation contained no provision as to how the election should be made and no requirement of any formality. As regards the contention that the notification had been made retrospectively, the Judge rejected Marlow Gardner’s arguments based on the lack of certainty which would result if Marlow Gardner’s VAT status were to be dependent on the subsequent notification by Net Support. The Judge concluded that there was nothing which rendered a notice of election made after the disposal of the land in question ineffective.

James Aitken, Tax Associate comments:

Sometimes when reading these decisions it is what is not said that is interesting. I can imagine the purchaser’s shock when finding out that the seller was charging VAT on the sale. I suspect that the first thing the purchaser said was: "it can’t bloody well do that" or words to that effect. The purchaser, being a financial institution, would be well aware that, to it, VAT is a real cost as it cannot usually be recovered. I strongly suspect that this was followed by a number of interesting phone calls and e-mails between the parties and their advisors.

So why did the seller decide to notify HMRC of its decision to opt to tax after the property had been sold? In short, it did not have much choice.

I can guess what is likely to have happened here. Someone probably asked about VAT early on in this transaction and a mistake was made. There are a number of possibilities. The person that deals with VAT for the seller did not know that VAT had already been charged on a lease or that VAT had been recovered on the building of an extension and simply concluded that no option to tax was in place. Alternatively, even if that person did know that VAT had been both charged and recovered on this property he might have thought that you can pick and choose on what transactions you charge VAT. Unfortunately that it is not the case. Another possibility is that someone knew that the purchaser could not recover VAT so simply concluded that it was best not to charge VAT on the sale.

In any case the result was that the purchaser did not know VAT was going to be charged.

I suspect that the seller realised that it should have been charging VAT shortly after the sale completed. The seller now had a decision to make. Who do I annoy: the purchaser or HMRC? Not a fair contest. A VAT enquiry into previous VAT charged and recovered would be opened. Dealing with a VAT enquiry is expensive and would take up a lot of time and it is likely that a penalty would have been imposed. Interest will also be charged on any loss of revenue to HMRC. In short, the seller was between a rock and a hard place.

On discovering the mistake, the seller, after panicking, will probably have looked at the sale contract. The contract should have stated that the seller had not and would not opt to tax the property. My guess is that the contract did not say this as the purchaser simply would have sued the seller for breach of contract when it received a VAT bill. Even if the contract had said that VAT was not to be charged on the sale, the seller did not have any real choice but to charge VAT on the sale of the property as it had earlier charged and recovered VAT on this property.

The next question someone would have asked was where the option to tax for the charging of VAT on the lease of part of the property was. When it was discovered that this did not exist, the seller would have been very pleased to find out that as long as there is evidence of the decision to opt to tax being made, the notification of the option can usually be made retrospectively. Two things are required before VAT can be charged on the sale of commercial property. Firstly the seller has to decide to opt to tax and secondly notification of the decision has to be given to HMRC. The notification should be made within 30 days of the decision being made but HMRC allow retrospective notification in most cases.

So why did the purchaser pursue this? In most property transactions where VAT is charged the purchaser simply recovers any VAT charged in its next quarterly return. The problem for the purchaser in this case was that as a pension company it could not charge or recover VAT. Most financial institutions cannot charge or recover VAT.

It is also worth noting that even with a purchaser that can recover VAT, it is best to provide in the contract where a vendor has stated that it has not opted to tax, that it will not at any point opt to tax. You don’t want a seller, as happened in this case, suddenly deciding to charge VAT even though you can probably recover the VAT as there will be additional SDLT to pay as SDLT is paid on VAT.

The court held in this case that the seller had decided to opt to tax as it could be shown that VAT had been charged on the leasing of part of the property and VAT was also recovered when an extension to the property was built by the seller. This was also all noted in the seller’s quarterly returns. The court also held that even though notification to HMRC had not taken place at the time of sale the seller could retrospectively notify HMRC of its decision to opt to tax. The sting in the tail here is that by charging VAT on the sale the seller also increased the SDLT bill for the purchaser.

To be clear it is only the notification part of this process that can be made retrospectively. A decision to opt to tax cannot be made retrospectively. This has been HMRC practice for a number of years now.

So what can be learned from this case? The VAT treatment must be agreed in the sale contract and, if applicable, the seller must agree that they have not opted and will not opt to tax the property.

Case referred to:

Marlow Gardner & Cooke Ltd Directors Pension Scheme v Commissioners of Revenue & Customs

The full text of the decision is available from the British and Irish Legal Information Institute: here

RICS Scotland has recently issued an update reporting that it has met MSPs and Scottish Executive Officials to discuss both the Planning (Scotland) Bill and the proposed Planning-gain Supplement (PGS). Along with the Scottish Rural Property and Business Association, it has expressed concern over the potentially detrimental impact the Bill’s proposals may have on appeals against delegated decisions on applications classed as local under the new hierarchy. A further area of concern is the thresholds and the possibility that for residential developments anything under 300 units could be classified as 'local'. RICS Scotland point out that few developments of that size take place in Scotland at any one time.

In his article in the June 2005 edition of PU, James Aitken highlighted the Executive’s concern over potential conflict between the principles underlying the Planning (Scotland) Bill and the proposed PGS. The RICS also stresses the need to address the issue of the proposed PGS both through legislation and debate on possible implementation strategies. Recent reports that the government has decided to replace the proposed PGS with a roof tax levy on completed developments have been denied by the Treasury and the Department of Communities and Local Government who have stated only that an announcement will be made later in the year.