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HM Revenue and Customs Brief 56/09


HM Revenue and Customs -Tax Authorities

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Issued 26 August 2009

VAT treatment of yacht chartering or leasing activities

1. Background and aim

In Revenue & Customs Brief 11/07 we announced our concerns relating to VAT schemes through which private individuals incur little or no VAT on the purchase of pleasure craft. We have since investigated a number of such schemes which typically involve artificial leasing or chartering structures.

There are also, of course, many bona-fide businesses who charter and lease pleasure craft. The aim of this Brief is to clarify our view of the VAT treatment applying to the purchase and use of pleasure craft and, in particular, the chartering and leasing of pleasure craft. We also set out our approach to artificial structures such as those described in Revenue & Customs Brief 11/07.

The term ‘pleasure craft’ is used to describe motor and sailing yachts which are designed for recreational use. This guidance takes into account relevant case law including the ECJ’s judgement in the case of Halifax and others C-255/02 (the Halifax case).

2. VAT registration

Persons who are in business and are either making or intending to make taxable supplies, relevant EC acquisitions, distance sales or supplies of certain assets may be liable or entitled to register for VAT.

'Business' is defined in Section 94(1) of the VAT Act 1994 (VATA1994) as including any trade, profession or vocation. This definition is not designed to be exhaustive and the VAT meaning of business has emerged through the judgements of UK courts and the ECJ. Although the Principal VAT Directive refers to 'economic activity' rather than 'business' our domestic legislation must be interpreted so it conforms with the Directive. Consequently 'business' and 'economic activity' must be seen as having the same meaning.

A person carrying out yacht chartering or leasing is therefore only entitled to VAT registration (and the related entitlement to deduct input VAT) where the chartering or leasing is carried out in the course of an economic activity. We may ask for evidence to show that an economic activity is being pursued, either before registration is allowed or during subsequent verification.

The ECJ case of Enkler [C-230/94] shows that, where an asset is suitable for both business and for private purposes, then the Tax Authority has to consider all the circumstances in which it is used to determine whether it is actually used in the course of a business. The actual length of the period for which the vessel is hired, the number of customers and the amount of earnings are factors which, forming part of the circumstances of the case as a whole, may be taken into account, together with others. In addition the actual use should be compared with the circumstances in which the corresponding economic activity is usually carried out.

During any verification of entitlement to VAT registration we will look for evidence that a chartering or leasing activity has sufficient substance and continuity to meet the criteria set by the ECJ in Enkler. We will also consider the evidence in relation to the ‘business test’ that emerged from the case of Lord Fisher QB [1981] STC 238, and the earlier case of Morrison’s Academy CS1977, [1978] STC1. The full circumstances in which the vessel is used will be considered and the onus will be on the registered person (or the applicant) to provide sufficient evidence to support a contention that the vessel is used in an economic activity.

3. VAT treatment of private (non-business) use of a pleasure craft

We are aware that the purchase of a pleasure craft is typically funded by a high net worth individual who agrees the specification with the supplier and who will use the vessel himself for some or all of the time that it is in service.
Such an individual may have legal ownership of the vessel in his own name or he may arrange for legal ownership to be held by a company (or other entity) which he may control, directly or indirectly.

When an individual has legal ownership of the vessel in his own name

If an individual has legal ownership of the vessel in his own name and uses it wholly for his own private use then there is no economic activity and he is not entitled to register for VAT.

Mixed business and private use

If an individual has legal ownership of the vessel in his own name and charters the vessel to others with sufficient continuity and substance to comprise an economic activity as well as using it himself then the vessel will be used partly for business and partly for private use.

If he is registered for VAT because of the business use he will incur VAT on goods (the vessel) that are intended for both business and private purposes.

He has a choice as to how to treat these goods for VAT purposes:

  • He may treat them as a part business, part non-business asset, in which case the VAT incurred is only deductible to the extent that it relates to the taxable business activities [section 24(5) VATA1994].
  • He may treat them as a wholly business asset, the 'Lennartz' approach, in which case the VAT incurred is treated as input tax and is deductible in full, subject to any partial exemption ('PE') restriction. However, VAT must then be accounted for when the goods are used for private purposes. Where a taxable person adopts the ‘Lennartz’ approach he must do so at the time the input tax is incurred.

If the asset is subsequently sold within the UK, VAT will be due on that ‘portion’ of the asset that is treated as business (in the circumstances described above) and on the whole of the asset (in the circumstances described above).

Further information on the application of the ’Lennartz mechanism’ is given in VAT Information Sheet 14/07.

When an individual arranges for legal ownership to be held by a company (or other entity)

The nature of the entity which owns a vessel does not, in itself, affect the VAT treatment of the vessel.

However, we are aware that structures involving a company (or an entity such as a limited liability partnership) have been used by individuals to obtain a VAT advantage. Put simply, this arises where an individual who has funded the purchase of a pleasure craft arranges for legal ownership of that vessel to be held by a company (or other entity) which registers for VAT as a chartering or leasing business and recovers VAT incurred on the purchase and operation of the vessel.

The individual’s own use of the vessel is covered by charter or lease agreements issued to him in the name of the company. As a result it is claimed that there is no private use of the vessel.

We will consider the entitlement of such a company (or other entity) to VAT registration by applying the approach set out above to identify whether the chartering or leasing comprises an ‘economic activity’.

The connection between the company and the user of the vessel does not in itself prevent the chartering or leasing being an economic activity. On the other hand, merely issuing charter agreements to the individual in the name of the company is not, alone, sufficient to create an economic activity. The full circumstances in which the vessel is used will be considered, as explained above.

We may also consider whether the structure amounts to an abusive practice by applying the tests identified by the ECJ in the Halifax case. More information on this aspect is given below.

4. Application of the principle of prohibiting abusive practices

In recent years there have been significant developments in the case law of the ECJ concerning the application to VAT of the principle of prohibiting abusive practices. Of particular relevance are the ECJ’s judgements in the Halifax case and in the case of Part Service Srl C-425/06.

From these cases it is clear that:

The principle of prohibiting abusive practices 'applies to the sphere of VAT' (Halifax, paragraph 70). This means it applies to all aspects of VAT and not just the right to recover input tax. This was further demonstrated in the Part Service case which concerned avoidance of output tax.

The tests to establish whether an abuse exists are as follows:

'For it to be found that an abusive practice exists, it is necessary, first, that the transactions concerned, notwithstanding formal application of the conditions laid down by the relevant provisions of the Sixth Directive [now the Principal VAT Directive] and of national legislation transposing it, result in the accrual of a tax advantage the grant of which would be contrary to the purpose of those provisions. Second, it must also be apparent from a number of objective factors that the essential aim of the transactions concerned is to obtain a tax advantage.' (Halifax paragraph 86).

With regard to the first test ('contrary to purpose'), if the objective facts show that the economic reality underlying the structure is that an individual has purchased a pleasure craft for his own recreational use then, if no VAT is borne by that individual in relation to the purchase and use of the pleasure craft, that result may be contrary to article 1(2) of the Principal VAT Directive (1).

With regard to the second test, 'essential aim' is determined by considering 'the real substance and significance of the transactions concerned' taking account of 'the purely artificial nature of those transactions and the links of a legal, economic and/or personal nature between the operators involved in the scheme for reduction of the tax burden' (Halifax paragraph 81).

It is important to note that 'essential aim' is not a sole purpose test. There can be a finding of an abusive practice when the accrual of a tax advantage constitutes the principal aim of the transaction or transactions at issue (Part Service paragraphs 45 and 62).

The essential aim of the transactions concerned is determined from the objective facts of the case rather than the subjective aim or intention of the parties engaged in those transactions. It is an 'objective' test which does not rely on establishing what the parties say their intention was (or what their subjective intention is found to have been). Instead, the essential aim is established by taking account of all the evidence and the commercial realities to determine what, viewed objectively, is the principal aim of the transactions viewed as a whole.

Where an abusive practice is found to exist then:

'It follows that transactions involved in an abusive practice must be redefined so as to re-establish the situation that would have prevailed in the absence of the transactions constituting the abusive practice.' (Halifax paragraph 94).

If we conclude that a structure meets the tests for an abusive practice then we will consider appropriate action to restore the situation that would have existed in the absence of the abusive transactions. This might include issuing assessments to disallow input tax and/or deregistration of the entity concerned. Such assessments might also give rise to interest charges and penalties.

5. Possible Indicators of an Abusive Practice

The existence of one or more of the following features might indicate an abusive structure (the list is not exhaustive - the indicators are illustrative of the points that we might take into account, together with others):

The main user of a pleasure craft is the ultimate owner of the chartering or leasing entity.

The main user of a pleasure craft funded the purchase of the vessel (directly or indirectly).

The person who funded the purchase of a pleasure craft (directly or indirectly) uses the vessel for prolonged periods in the peak chartering season.

The chartering of a pleasure craft to third parties would not, alone, be of sufficient continuity and substance to comprise an economic activity.

The chartering or leasing entity shows significant ongoing losses in its financial statements.

Charter fees or lease instalments due from the main user of a pleasure craft are paper transactions only (for example being offset against loans).

Charter fees or lease instalments are below open market value.
The terms of a lease differ significantly from normal commercial practice (for example, the duration of the lease is unusually long).

Who can I contact for further information?

If you have a query for which you have been unable to find the answer within this publication, please contact HMRC’s Advice Service for VAT on 0845 010 9000 (+44 208 929 0152 for International callers). The Advice Service VAT helpline is available from Monday to Friday, 8.00 am to 8.00 pm (GMT).

(1) Article 1(2) states: 'The principle of the common system of VAT entails the application to goods and services of a general tax on consumption exactly proportional to the price of the goods and services, however many transactions take place in the production and distribution process before the stage at which the tax is charged.'

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© Crown Copyright 2009.

A licence is need to reproduce this article and has been republished for educational / informational purposes only. Article reproduced by permission of HM Revenue & Customs under the terms of a Click-Use Licence. Tax briefs are updated regularly and may be out of date at time of reading.

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Article Published/Sorted/Amended on Scopulus 2009-08-28 17:14:31 in Tax Articles

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