Hanuman Commercial Ltd v HMRC considered whether novation of a contract for the sale of land was an exempt supply of land or a separate supply of services for VAT purposes.
What is novation? In essence, a novation has the effect of replacing one party to a contract with a new party. Novation takes place when one party to a contract releases the other contracting party from its contractual obligations in consideration for a third party assuming those obligations.
The facts in this case: In Hanuman Commercial Ltd v HMRC [2017] UKFTT 854 (TC), Sabre Insurance Company Limited (Sabre) entered into the original contract for the sale of a property (the ‘Sabre contract’) for £2.8m with Hanuman Commercial Limited (HCL). Before completion, HCL entered into a contract with Connect Centre Limited (CCL) for the onward sale of the property for £5.5m (the ‘CCL contract’). A number of subsequent agreements varied these two contracts.
Essentially, the result was that by a deed of novation between the three parties, HCL’s rights and obligations under the Sabre contract were novated to CCL so that CCL would acquire the property from Sabre. On completion, CCL paid £2.8m to Sabre and £2.7m to HCL (to make up the total consideration of £5.5m).
HCL had initially purported to charge VAT on invoices it issued to CCL but subsequently decided that VAT was not properly chargeable. HMRC disagreed and issued an assessment for this VAT. HCL then appealed against the assessment.
The judgment: HCL argued that it had made an exempt supply of an equitable interest in the property to CCL, as it was obliged to do under the CCL contract. The VAT treatment should follow the economic reality of the transaction, which was that there was a transfer of an interest in the property from HCL to CCL.
HMRC’s position was that the exemption did not apply because HCL did not supply a freehold interest in the property to CCL. The original contract between Sabre and HCL was novated and thus, the property went directly from Sabre to CCL. CCL was paying HCL to step away from its contract with Sabre rather than to transfer the property to it.
Judge Robin Vos found that, prior to the novation, HCL did have an equitable interest in the property and an obligation to transfer this interest to CCL under the CCL contract. However, the effect of the novation was to ‘rip up’ the original contract with the result that it was as if it had never existed and HCL’s obligations under it fell away.
Instead, under the novation agreement, HCL granted CCL the right to enter into an agreement with Sabre to purchase the property. The grant of this right was not an exempt supply of land but a supply of services. VAT was due on the supply of services, which was standard rated in this case.
Conclusion: Novations are often a problematic area of law. As it stands, in the case of a contract for the sale of land, a novation is to be treated as a separate supply from the underlying supply of the land and may therefore be subject to different VAT treatment.
In this case, part of the rationale for novating the contract, rather than the land being transferred from Sabre to HCL and then on to CCL, was to ensure that the transaction would be treated as a transfer as a going concern for VAT purposes (and therefore outside the scope of VAT).
The judge remarked that, since it was intended that the novation should alter the VAT treatment of the transaction in general, it was not surprising that it also altered the VAT treatment of the supply by HCL.
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Can the novation of a contract be a supply of land?
Hanuman Commercial Ltd v HMRC considered whether novation of a contract for the sale of land was an exempt supply of land or a separate supply of services for VAT purposes.
What is novation? In essence, a novation has the effect of replacing one party to a contract with a new party. Novation takes place when one party to a contract releases the other contracting party from its contractual obligations in consideration for a third party assuming those obligations.
The facts in this case: In Hanuman Commercial Ltd v HMRC [2017] UKFTT 854 (TC), Sabre Insurance Company Limited (Sabre) entered into the original contract for the sale of a property (the ‘Sabre contract’) for £2.8m with Hanuman Commercial Limited (HCL). Before completion, HCL entered into a contract with Connect Centre Limited (CCL) for the onward sale of the property for £5.5m (the ‘CCL contract’). A number of subsequent agreements varied these two contracts.
Essentially, the result was that by a deed of novation between the three parties, HCL’s rights and obligations under the Sabre contract were novated to CCL so that CCL would acquire the property from Sabre. On completion, CCL paid £2.8m to Sabre and £2.7m to HCL (to make up the total consideration of £5.5m).
HCL had initially purported to charge VAT on invoices it issued to CCL but subsequently decided that VAT was not properly chargeable. HMRC disagreed and issued an assessment for this VAT. HCL then appealed against the assessment.
The judgment: HCL argued that it had made an exempt supply of an equitable interest in the property to CCL, as it was obliged to do under the CCL contract. The VAT treatment should follow the economic reality of the transaction, which was that there was a transfer of an interest in the property from HCL to CCL.
HMRC’s position was that the exemption did not apply because HCL did not supply a freehold interest in the property to CCL. The original contract between Sabre and HCL was novated and thus, the property went directly from Sabre to CCL. CCL was paying HCL to step away from its contract with Sabre rather than to transfer the property to it.
Judge Robin Vos found that, prior to the novation, HCL did have an equitable interest in the property and an obligation to transfer this interest to CCL under the CCL contract. However, the effect of the novation was to ‘rip up’ the original contract with the result that it was as if it had never existed and HCL’s obligations under it fell away.
Instead, under the novation agreement, HCL granted CCL the right to enter into an agreement with Sabre to purchase the property. The grant of this right was not an exempt supply of land but a supply of services. VAT was due on the supply of services, which was standard rated in this case.
Conclusion: Novations are often a problematic area of law. As it stands, in the case of a contract for the sale of land, a novation is to be treated as a separate supply from the underlying supply of the land and may therefore be subject to different VAT treatment.
In this case, part of the rationale for novating the contract, rather than the land being transferred from Sabre to HCL and then on to CCL, was to ensure that the transaction would be treated as a transfer as a going concern for VAT purposes (and therefore outside the scope of VAT).
The judge remarked that, since it was intended that the novation should alter the VAT treatment of the transaction in general, it was not surprising that it also altered the VAT treatment of the supply by HCL.
