A slow-moving business or clear trails of a sham? A story of snail farming and business rates mitigation schemes

One could forgive local authorities for thinking that, in recent years, the direction of case law concerning liability for business rates has been an untrammelled disaster for those looking to unravel thinly-veiled mitigation schemes. To that end, the High Court decision of Isle Investments Limited v. Leeds City Council [2021] EWHC 345 (Admin) may provide some comfort. 

Who pays business rates?

The person in rateable occupation of commercial premises will be the party liable to pay business rates to the local authority. If the property is not let, the liable party will be the freeholder. However, if the freeholder leases the whole or any part of said premises to a third party, that party will be in rateable occupation in respect of the premises demised to them.

Sham arrangements

Notwithstanding the above, the landlord will remain liable for business rates if it transpires that the lease to a third party is a "sham". For a lease to be a sham, the court must be convinced that (i) the parties intended to create different rights and obligations from those appearing in the lease and (ii) they intended for the lease to give a false impression of those rights and obligations to third parties¹.

In assessing whether a lease is a sham, the court is not limited to examining the lease in question and may assess external evidence, such as the parties' explanations for any discrepancies, as well as the subsequent conduct of the parties after the lease is entered into. However, case law has confirmed that a court should not readily find that a lease is a sham without substantial evidence to support that conclusion.

Background

Isle Investments Limited (Isle) had sought to avoid liability for business rates upon acquiring Airedale House in Leeds, a building which primarily comprises office space. To achieve this, it had entered into an arrangement with a company specialising in rates mitigation schemes. In brief, this scheme resulted in Isle granting a number of short leases of various units to special purpose vehicle companies. In return for entering into the leases, Isle would pay the "tenant" 20% of the business rates owed for each unit.

For the most part, the leases contained terms typically seen in rates mitigation arrangements, such as conferring exclusive occupation to the tenant and, bar a £1 annual rent, only requiring the tenant to pay any business rates due during their period of occupation. However, the majority of the leases also contained a bemusing but salient term restricting the use of the premises "for the purpose of heliciculture" – the farming of snails – despite the units being offices (the User Clause).

Following inspections of each unit, a representative of Leeds City Council determined that the leases were shams on the basis there was no evidence that there was a real intention to confer exclusive occupation to the tenants. The main evidence in support of this conclusion was that the User Clause in the leases meant no legitimate business could take place. Additional evidence included the fact that the tenant had made an unconvincing attempt to demonstrate snail farming was actually taking place, as well as the fact that the tenant had seemingly failed to maintain any meaningful presence at the units.

At first instance, Leeds Magistrates Court agreed and held the leases were a sham. Accordingly, the court found that Isle remained liable for the business rates and granted a liability order in favour of the local authority. Isle appealed on the basis that, on the evidence before it, the court could neither logically nor lawfully determine that the leases were shams.

Decision

Following a lengthy review of recent case law and the first-instance judgment, the High Court dismissed Isle's appeal and upheld the original decision to grant a liability order.

The High Court's reasoning heavily focused on the difference between the apparent nature of the relationship between Isle and its tenants under the scheme (i.e. a lease granting exclusive occupation to the latter) and the true nature of that relationship (i.e. documents with which neither party intended to comply) as assessed by the lower court. The High Court found that the lower court had been entitled to rely on a number of facts that supported its decision to hold the leases were a sham, including but not limited to:

• there was no evidence of actual occupation on any inspection of the units;
• the User Clause meant the "intended" use of the units was practically impossible as the offices were not suitable for snail farming;
• there was a complete absence of due diligence undertaken for the tenants by Isle;
• the director of Isle admitted that they did not expect the tenant to meaningfully occupy the units (as they would have carried out due diligence if they did); and
• the director of Isle had been an unconvincing witness and appeared to be actively trying to mislead the court at trial as to the parties' intentions.

The court was also keen to confirm that, while entering into a lease for the primary purpose of avoiding rates was not prima facie evidence of a sham, it was nonetheless a factor pointing towards a sham taking place. If this factor was coupled with other substantial evidence which suggested the apparent nature of the lease did not reflect its true nature, a court would be entitled to conclude the arrangement was a sham.

Commentary

On the face of it, one could read this decision as a rare but significant victory for local authorities. Indeed, some commentators have chosen to focus on the fact that, despite the ratepayer's heavy reliance on arguments successfully advanced in recent recorded cases (the facts of some could be said to be strikingly similar to Isle), the court was unmoved and maintained that the leases were shams.

We would respectfully disagree with this analysis. While it is indeed a rare victory on appeal, readers should assess Isle on its facts, which can be summarised as the ratepayer engaging in an admittedly novel, but undoubtedly poorly planned, rates mitigation scheme. We are of the view that the decision should instead be interpreted as a clear lesson to those engaging in rates mitigation schemes: be convincing, be transparent and be consistent. Isle should also be a reminder that rates mitigation schemes do not need to re-invent the wheel to be successful. 

1. Hitch v. Stone [2001] EWCA Civ 6↩