Sale Of Let Property: The Transfer Of A Business As A Going Concern ("TOGC")

1. Value Added Tax

The sale of a business as a going concern attracts specific VAT treatment. Provided certain conditions are met by both parties to the transaction, VAT is not chargeable by the vendor nor payable by the purchaser. That exemption may apply not only to a trading business, but also to the sale of a let property, which is regarded by HM Customs & Excise as a business. Consequently, if an investor sells a let property to a third party, it is possible that VAT will not be payable. Indeed, the issue goes further than that. Customs & Excise have decreed that the vendor must not charge VAT (Article 5: VAT (Special Provisions) Order 1959, S.I. 1995/2168). The TOGC regime provides a useful but limited cashflow advantage to the purchaser where it can be utilised. More importantly, stamp duty is reduced because there is no VAT uplift on which it can be charged.

2. Registration And Waiver Of Exemption

The TOGC regime applies in the main to commercial and not residential properties. Commercial properties are generally not subject to VAT unless:-

• they are new properties; that is to say that they have been built within 3 years prior to the disposal which gives rise to a VAT charge. They are then charged at standard rate; or
• the vendor has elected to waive its exemption to tax or, to use different wording having the same effect, has exercised its option to tax.

Before the exempt vendor can bring itself within the VAT regime, it must be registered for VAT with Customs & Excise;

3. Means And Effect Of Waiving Exemption

Exemption is waived in relation to a particular building or buildings. It cannot be waived in general terms, ie. by a vendor notifying Customs & Excise that it wishes to be treated as having waived its exemption in relation to any future properties that it may purchase. The property must be clearly identified. Further, to avoid any risk, the property owner should await receipt from Customs & Excise of an acknowledgement that they have received and accepted the waiver.

The effect of the waiver is to require the owner to account for VAT on any proceeds of sale or rentals achieved by it. Consequently, if the owner does not charge VAT to a purchaser or lessee, any monies received from the purchaser or lessee will be deemed to be VAT inclusive and the owner will have to account to the Revenue for the VAT element, retaining only the net sum.

4. TOGC Conditions

The TOGC regime arises when a vendor intends to sell a let property upon which, in the absence of that regime, it would charge VAT. If the transaction is a TOGC, the vendor cannot charge VAT if various conditions are met. It does not have a choice.

These conditions are:-

1. The vendor and the purchaser are both registered for VAT or will become liable for registration or will be accepted for voluntary registration by the time of the sale (prudently prior to exchange of contracts).
2. The purchaser intends to carry on the same business of letting the property. It is not relevant that it may be a developer whilst the vendor is an investor. The purchaser can still demonstrate that it intends to continue the letting. (Halborough Properties Limited – Tribunal Case No. 19849).
3. There must be no break in the business, either before or after the sale. That is to say, the tenancy must continue.
4. Where the property being sold represents part of the business of the vendor, then such part being purchased is capable of separate operation as a business.

The vendor and the purchaser must also elect to waive exemption in relation to the property, unless it is a new property where that is not necessary, giving notice of that fact to Customs & Excise prior to the date upon which a supply for VAT purposes on the sale of the property would normally arise. This was always thought to be completion. However, see paragraph 9 which refers to a recent Tribunal decision that could require elections to be made by the purchaser prior to exchange in certain circumstances.

5. Consequences Of A TOGC

5.1 The vendor will not and must not charge VAT upon the sale.

5.2 The vendor will have to pass to the purchaser the VAT records it has maintained relating to the business, (ie. the letting) during its period of ownership. However, it is open to the vendor to request Customs & Excise's permission to retain these records (Section 49(1)(b) Value Added Tax Act 1994) and it is usually sensible to do so. Customs & Excise normally require a reason for such an election. The reasons put forward successfully revolve around business confidentiality, difficulties in extracting the records relating to the letting business from other business records held by the vendor and the like. There is usually no difficulty in obtaining the direction.

5.3 The purchaser may become liable to the Capital Goods Scheme in the place of the vendor. (See paragraph 10).

5.4 As no VAT has been paid by the purchaser to the vendor, the latter does not have to account for VAT to Customs & Excise.

6. Practical Problems

Does a TOGC arise?

There are often ambiguous cases where the existence of a TOGC is questionable. The following may give rise to concern:-

6.1 The property is only partly let:

• if the unlet part is available for letting, Customs & Excise will allow the whole of the property (including the unlet part) to qualify for TOGC relief.
• where the business being sold comprises a portfolio of properties, it may have within it a number of dormant properties. If within such a portfolio it is normal for a percentage of the properties to be out of action, then they may still qualify for TOGC relief, even though they are not let.
• Customs & Excise may also permit TOGC treatment on the sale of a 'commercial' building, even though it was partly let on a residential basis, ie. the residential letting of a flat above a shop.

6.2 The sale of the property is to a tenant of that property:

• such sale is not considered to be a TOGC by Customs & Excise.

6.3 The letting is unprofitable or the vendor is in receivership/liquidation:

• the fact that the lettings are not profitable will not necessarily cause the existence of a business to be denied and therefore TOGC relief may be available.
• furthermore, the fact that the vendor is trading under the control of a liquidator, administrative receiver, a trustee-in-bankruptcy or an administrator appointed under the Insolvency Act 1986 would not debar the sale from being that of a TOGC.

6.4 The sale of the property is to the vendor's landlord:

• in these circumstances, the tenant would be surrendering its lease to the landlord. It is Customs & Excise's view that this would not represent a TOGC. It may be argued that were the landlord to enter into a declaration of non-merger, it would be open to the tenant to suggest that the sale in these circumstances would not be a surrender and would therefore be a TOGC. However, Customs & Excise are unlikely to accept the argument.

6.5 The sale will take place by way of sub-sale:

• the vendor enters into an agreement to sell the let property to B who, in turn, agrees to sell it to 'C'. On completion, the vendor conveys directly to C. It is the view of Customs & Excise that there will not be a TOGC either on the transfer from the vendor to B or on the transfer from B to C. This can commonly occur in a situation where a group is seeking to mitigate Capital Gains Tax by transferring the property to its capital loss company prior to a sale. Generally, VAT is chargeable. However, it may be possible to achieve TOGC treatment if the 'business' is held by the intermediate company for more than one week. Indeed, in more recent times, Customs have suggested that if some apportionment is made on the sub-sale showing that the intermediate person has received rent, this may be sufficient.

6.6 The purchaser ceases to carry on the trade of letting or indeed sells on its interest in the property some short time after the purchase:

• one of the conditions for TOGC relief to be granted is that the purchaser carries on the same trade of letting as that carried on by the vendor. If the purchaser ceases to carry on such trade after a fairly short space of time following its purchase, or sells on its interest, Customs & Excise will be able to argue that this condition has not been met. The consequence will be that the original transfer should not have been a TOGC and VAT should have been charged on the sale. Thus, if it can be argued that the purchaser has broken this condition, the vendor will be exposed to the possible application of penalties and interest on the VAT that should have been charged at the time of the sale. In practice, where a vendor has taken all reasonable steps to satisfy himself that the condition will be met, eg. requesting warranties, a breach by a purchaser should not give rise to VAT penalties.
• the question of whether or not the purchaser carries on the business of letting is one of fact. Thus, it is not possible to offer a definitive view as to whether the purchaser would have broken this condition or not by ceasing the business post purchase. The intention of the purchaser at the time of purchase would of course be a significant factor. However, it is a danger that should not be overlooked by the vendor.

6.7 The purchaser buys the freehold interest at the same time as it buys the leasehold interest from the vendor:

• this is not a TOGC because the business asset of the leasehold interest disappears by way of merger with the freehold interest and cannot therefore be used for business purposes by the purchaser.

7. Consequences Of Charging Vat On A Sale Of A TOGC

7.1 What happens where a vendor sells the property as a TOGC but charges VAT, overlooking the existence of the TOGC?

• from the purchaser's point of view, it has been incorrectly charged VAT on the sale of the TOGC. As the purchaser has not, in effect, paid VAT, it cannot recover the amount charged under its VAT return. The purchaser is therefore out of pocket to the extent of the amount incorrectly charged.

7.2 The vendor has incorrectly charged VAT, issued an invalid VAT invoice and remitted the VAT to Customs & Excise within its returns

• although VAT should not have been charged, Customs & Excise may not return the amount in question.

Consequently, the only loser is the purchaser. It will be open to the purchaser to seek to sue the vendor for the return of the VAT incorrectly charged. If the vendor cannot recover from Customs & Excise, it is unlikely to be co-operative; and if the vendor is an overseas company with no assets in the UK recovery may be difficult in any event. Consequently, a purchaser must be alive to the existence of a TOGC, as it may suffer considerable loss if it incorrectly pays VAT against a VAT invoice which should not have been issued.

8. Consequences Of Incorrectly Characterising A Sale As A TOGC

This situation arises where the vendor believes the sale to be within the TOGC regime and does not charge VAT. It subsequently emerges that the sale was not a TOGC, with the consequence that VAT should have been charged upon the sale price. If under the terms of the documentation the sale price was expressed in the contract or deemed to be VAT exclusive, then upon this subsequent revelation, the vendor could charge VAT to the purchaser and recover it if the purchaser has assets available. However, depending upon when the VAT was charged, the vendor might be exposed to the imposition of interest and penalties for a late charge. Further, if the consideration was silent as to VAT, the vendor may not be able to charge VAT.

It is normal for a contract purporting to establish a TOGC to impose warranties on both parties that they have complied with the necessary conditions. Further, the purchaser will undertake that if the transaction is found not to be a TOGC, it will pay over the necessary VAT sum against a proper invoice. Where the vendor suspects that the purchaser may not have sufficient asset strength to back this obligation, it should negotiate the payment by the purchaser of a deposit, in addition to the purchase price, sufficient to cover any VAT which may become chargeable. There may be cases where the TOGC is itself in doubt and in that event it is wise to be cautious. Customs will give a ruling on a complex case where the TOGC position is not clear. They will not respond to applications for prior clearance on transactions which bear all the ingredients of a TOGC and appear to give rise to no difficulties.

It is normally for the vendor to categorise accurately whether or not the supply constitutes a TOGC. However, responsibility must also be placed upon the purchaser to satisfy the conditions which apply to him.

9. Deposits

The payment of deposits creates certain problems, where those deposits are treated as payable either to the vendor or to a third party, as the vendor's agent. Deposits are normally paid on exchange of a purchase contract and generally the deposit is held by a stakeholder, to be released at completion to the vendor. In those circumstances, no tax point occurs until completion.

However, where the deposit is held by the vendor or a third party as agent for the vendor, a tax point is created on payment being made or becoming due. The vendor should then charge VAT on the deposit unless the sale is a TOGC. Where the deposit is dealt with in this manner, the TOGC requirement that the purchaser should elect to waive exemption to tax and give notice to Customs of such election before the first tax point will mean that notice must be given prior to payment of the deposit at exchange. That is all very well where the transaction is proceeding as a private treaty, but in such a case, the deposit is normally paid to a third party as stakeholder, in any event.

An auction purchase creates problems. In that case, the deposit is often paid over to the auctioneer, as the vendor's agent. The purchaser may only decide to bid for the particular property "in the room". As notice of waiver of exemption must be given in relation to a specific property and in writing, there is no possibility of that course of action being taken before the property is knocked down to the purchaser. Consequently, the transaction will not be a TOGC and VAT will have to be paid, both on the deposit and the balance of the completion money. It cannot be converted into a TOGC once contracts are exchanged because the tax point has then passed. (This issue has been considered by the Court in Higher Education Statistics Agency Limited -v- The Commissioners of HM Customs & Excise).

10. Capital Goods Scheme

10.1 The capital goods scheme applies to land and buildings use for non-taxable purposes. The provisions do not apply to property acquired or brought into use before 1^st April 1990. Non-taxable use will include occupation by organisations which cannot recover VAT, eg. banks and insurance companies. The scheme will apply to land or a building or part of a building where the value of interest is £250,000 or more. The rules also cover major refurbishments.

10.2 The scheme is designed to prevent avoidance of VAT. Without it, a purchase could purchase a property, use it for a short period for fully taxable purposes thereby reclaiming all VAT on the acquisition, and thereafter use it wholly for exempt purposes.

10.3 The scheme works by considering the use made of the land or the building over a 10-year period and adjusting the percentage of VAT originally claimed by reference to initial use by comparing that with subsequent use. For example, if the initial use appears to have been fully taxable so that all VAT was reclaimed, but it was subsequently revealed that the land or property was or became exempt, a claw back of previously recovered VAT would arise.

10.4 On the transfer of the relevant property to the purchaser, it is the purchaser's responsibility to assume the risk of any subsequent adjustment. Consequently, it should seek all relevant information from the vendor prior to purchase. In the case of an investment purchase, it is unlikely that such an adjustment could arise under present law, but a change of law or a decision to occupy an investment property could lead to a claw back of VAT previously reclaimed by the vendor.

11. Conclusion

TOGC's are normally relatively straightforward, but like any other transactions which have tax consequences, they have to be watched carefully. A mistake in structure or failure to recognise the true facts of a particular case can prove extremely expensive.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.