19 March 2019 - Article
A recent VAT court decision, in the case of Lok’nStore provides an opportunity to remind people about the relatively recent change in VAT rules concerning leasing land and buildings which the tenant uses for storage, as well as updating you on an interesting point relating to the treatment of VAT on costs of providing such premises.
Since October 2012 the leasing of property which is used by its tenant for storage purposes is compulsorily standard rated irrespective of whether the landlord has opted to tax the building. There are certain exceptions, in regard to related parties and charities, for instance, but the general position is that, if a tenant uses the premises for storage purposes, VAT applies. It is not necessary for the landlord to provide any additional storage-related services for this to be the case. Nor is it a requirement that the lease limits the use of the premises to a storage-related use, or specifically allows that use to apply. Even where the lease precludes use for storage purposes, which would appear to nullify the compulsory VAT treatment, the landlord still has to ensure that the tenant abides by that restriction or else VAT may apply. There can be issues over what is defined as ‘storage’ as opposed to simply ancillary storage which supports a principal activity, but this point is best discussed with professional advisers.
The Lok’nStore case was not really about that, but about the VAT on the costs of providing such storage service where, in addition to providing storage, the landlord also offers insurance of the contents being stored. This insurance was not supplied as a compulsory add-on to the lease, but, rather, could be selected as an added-extra for the tenant. Insurance supplies are exempt from VAT. HMRC took the view that all of the costs of running the storage business, including the construction or refurbishment of the premises let to the user, were related both to the taxable storage charges and to the exempt insurance charges pro rata to the turnover generated by both. Indeed, if the partial exemption method had been treated as the standard method then this would have been correct, since the standard method apportions all shared costs (overheads) by the ratio of turnover irrespective of whether the costs justify that allocation. It was impossible, in this case, to avoid the view that some parts of these buildings were used to generate insurance premiums, but the business argued that only the part relating to the administrative area, or front office, had that function. The costs of parts where the goods were actually stored could only be related to the storage lettings, which were taxable. Thus they argued for a special method to refine the cost allocation, and thus drastically reduced the leakage of VAT on their costs.
HMRC disagreed and the parties litigated. The first tier tribunal upheld Lok’nStore’s interpretation, but HMRC appealed to the upper tribunal. Although the upper tribunal was critical of some aspects of the reasoning of the first tier tribunal, it did not criticise that tribunal’s overall assessment to the effect that a fair and reasonable cost allocation would recognise that all of the costs which directly relate to storage should be treated as recoverable against the taxable supplies made, and only a proportion of the costs which had more general application should be apportioned in accordance with both income streams. The view, in essence, was that this was the most accurate management accounting solution. A sophisticated cost allocation approach would not take the view that the insurance activities had used all of the storage related costs, since the insurance was a spin-off, and not a direct consumer of all costs of the activity.
There are two lessons from this. First, the standard method will often produce an unfair result, and all businesses that make exempt supplies should consider trying to negotiate a special method as long as it acts in their favour so to do. Second, HMRC has a weak grasp of commercial use of costs, and commonly argues in its own favour for unrealistic cost allocation approaches. These should be challenged.
Businesses often assume that HMRC is invincible in such situations. Whilst it is true that a tribunal can only intervene where HMRC has been unreasonable, it is not at all unusual for HMRC to be unreasonable, and in such situations considerable sums can be saved by disputing the issue with HMRC, including litigation at the tribunal.