Julie Butler explains why the Babylon Farm case highlights the need to focus on the economic activity for VAT and other taxes too.
A key tax planning question is whether a farm or equine operation is carrying on a business or not – particularly with the current changes to farm subsidy arrangements, together with the commercial impact of the post-lockdown environment.
The recent Upper Tribunal (UT) case of Babylon Farm Limited v HMRC  UKUT 0224 (TCC) is of great interest when considering this question. The UT found that the First-tier Tribunal (FTT) had erred in law, but had been correct to find that the appellant’s hay supplies did not constitute an economic activity for VAT purposes. Questions to be dealt with were whether it was necessary for HMRC to deregister Babylon Farm Limited (Babylon Farm) and whether the farm was carrying on a business.
Babylon Farm sold hay to its director, Mr McLaughlin, who also owned the land from which the hay was produced. Mr McLaughlin set the price of the hay sale and decided which costs were borne by the company. With annual sales of only £440, the company claimed input VAT of more than £19,000, predominantly relating to the building of a new barn.
The FTT upheld HMRC’s decision to deny the claim for input VAT (Babylon Farm Limited  UKFTT 562 (TC)). The FTT also held that in order to claim that the company was not carrying on a business for VAT purposes, the company did not first need to deregister for VAT.
The FTT had agreed with HMRC, so Babylon Farm appealed to the UT as it was not satisfied with this verdict. The UT agreed with the FTT that Babylon Farm was not carrying on a business and confirmed it was not necessary for HMRC to cancel a VAT registration before claiming that a person was not carrying on a business.
Babylon Farm’s argument was that a person is a taxable person and so entitled to claim input VAT so long as that person is registered for VAT, according to the Value Added Tax Act 1994 (VATA 1994). It considered that the legislation requires HMRC (at para 13(2), Sch 1, VATA 1994), to deregister anyone who ceases to be registrable.
The commercial business
As farm and equine accountants and tax advisers, the question of whether an undertaking is a true commercial business or a hobby is often asked in terms of all taxes and VAT. Likewise, some farm and equine hobby operations have dramatic turnarounds and the business tax status of the operation has to be considered. For example, that one very large horse sale moves the hobby towards commerciality. The UT decision focused on the need to be operating in the open market, the economic activity and the importance for there to be evidence of carrying out actions to obtain income.
The UT was of the view that the farm was not in business and could not recover input tax on the costs of the new barn. The UT decided that it should remake the decision rather than remit it to the FTT. The judge stated that he could see no legal basis for the farm to be in business. The hay that the farm sold was taken from the customer’s (Mr McLaughlin’s) own land and therefore belonged to him already.
It was also noted that no invoices were raised, no payment for the hay had been made for a number of years and the single customer (Mr McLaughlin) was a director of Babylon Farm so the farm was not operating in open market conditions. The sale of hay had therefore not been conducted on a basis that followed sound and recognised business principles or on a basis that was predominantly concerned with the making of taxable supplies for consideration.
Babylon Farm also argued that it was also undertaking preparatory acts for the new business activities that Mr McLaughlin was developing. On this point, neither of the intended activities had yet resulted in any chargeable services being provided and both were to be carried on through companies that had been formed for these purposes (not the farm). Both businesses remained at a formative stage and neither company had generated any revenue.
The lack of commerciality was extreme.
Evidence of a business activity
The UT thought the FTT should have considered the Court of Appeal’s decision in Wakefield College v HMRC  EWCA Civ 952, instead of Fisher  2 All ER 147. The Court of Appeal in Wakefield was of the view that whether an activity was a business activity depended on whether it was carried out to obtain an income. In Babylon Farm, based on the facts found by the FTT, there was no direct link between the hay making and the income generated. There was no evidence of any efforts to obtain other customers.
While Babylon appears to be simply a technical VAT case, it does have capital taxes considerations. If there is no commercial business, then there is potentially no business property relief (BPR) for inheritance tax (IHT) and the capital taxes business reliefs – quite important in farming, especially with greater farm diversification into areas that need BPR.
As always, it is important to look at all taxes in the round. Despite all the changes in subsidies to ‘farming for the environment’, the value of farmland has remained high and the market values (s160, Inheritance Tax Act 1984) need the protection of IHT reliefs, especially BPR.
There have been tribunal cases in 2021 that review the importance of commerciality and that also focus on the mixed rate of stamp duty land tax (SDLT). For example, in the How Development 1 Ltd v Revenue & Customs  UKFTT 248 (TC), the FTT determined that the purchase of a substantial property and grounds consisted entirely of residential property and was subject to higher residential rates of SDLT.
This case shows the potential to help the future purchaser of a property with woodland as it can be more advantageous in SDLT terms to ensure that the woodland is commercial rather than left undisturbed/recreational. This is likely to remain the case even if the rules are changed following the current consultation on the SDLT mixed-property rules. Furthermore, commercial woodlands are generally better placed for IHT relief (eg, BPR), than dormant/recreational woodlands.
Being able to provide evidence of the commercial activity being undertaken prior to completion (and immediately after) is essential for SDLT. This has been seen in other recent 2021 SDLT cases. Where possible, the commercial activity should be referenced in the sales contract – even better if there can be an actual sale of a crop that can be evidenced. This could be the sale of standing timber or grass.
When it comes to operating woodland commercially, HMRC will expect to see evidence of historic and future timber sales (eg, some degree of management plan showing when the next sales are due). Historic barter arrangements – for example, woodland maintenance in return for timber sales for the woodlands – do not help; clear evidence of independent sales is much stronger.
Gather the evidence
In 2022 and subsequent years, it is anticipated that there will be even greater focus on the economic activity to achieve tax reliefs. Tax advisers must highlight weaknesses that need rectification as soon as possible.
About the author
Julie Butler FCA, Founding Director, Butler & Co