VAT on commercial land and property transactions can be a very complex area. If the VAT aspects are not considered, or are considered too late, or if you proceed without obtaining full information, the result can be an unexpected and costly VAT bill, penalties and interest levied by HMRC, often along with the need to enter into lengthy correspondence with HMRC to resolve the matter. Therefore it is important to obtain professional advice at the outset when embarking on any transaction that involves commercial land / property, even if the land/property is not the main part of the transaction. A summary of some of the key points to consider are noted below.
By default, sales, leases and other supplies of commercial land and property in the UK are exempt from VAT. Making an exempt supply means that the seller or landlord does not charge VAT on the sale price or rent etc – which could be seen as a good thing from the purchaser/tenants point of view. However, not charging VAT on the sale also means that the seller/landlord will not be entitled to recover VAT that they incur on costs relating to the property, such as legal fees, agency fees, or maintenance and repair work. VAT on costs could be significant and can impact profit – so, often, an exempt supply is not desirable from the seller/landlords point of view.
There are, however, several exceptions to the exempt default position. For example, some supplies of commercial property are liable to standard rate VAT whereas others are not liable to VAT as they are ‘outside the scope of VAT’.
Opting to charge standard rate VAT – the option to tax
The ‘option to tax’ allows sellers/landlords to convert what would otherwise be an exempt land/property transaction into a standard rated transaction. This means that sellers, landlords, developers, etc are able to recover VAT incurred on costs relating to the property which would not be recoverable if their supplies of the property were VAT exempt. The option to tax is therefore particularly valuable if the purchaser / tenant can recover VAT charged on any rents / lease / purchase / surrender / etc. However, businesses in VAT adverse sectors, such as banking, finance, insurance, education, health and charities, cannot usually recover VAT incurred on costs and they may prefer to seek properties from sellers/landlords that have not opted to tax. Or they may seek to negotiate a lower price to take account of the VAT that they will not be able to recover.
Once you have opted to tax your interest in a particular land/property, with one or two exceptions, you are required to charge and account for VAT on all future supplies you make of that property. Other than a 30 day cooling off period, to which conditions apply, the option to tax cannot be revoked for a period of 20 years. Therefore, it is crucial to obtain advice so that an informed decision can be made of whether to opt or not. Landlords of older properties that need work may decide to opt to tax in order to recover VAT on refurbishment costs. However, landlords of properties in, say, banking and insurance districts may decide not to opt in order to avoid a negative impact on their ability to sell / lease their property, as a significant number of potential buyers/tenants will not be able to recover VAT.
Other disadvantages of opting to tax are cashflow and SDLT. If a seller has opted to tax, the VAT payable by the buyer of a commercial property could be substantial. Even if the purchaser can recover the VAT, recovery is through the VAT return system and so the purchaser may have to wait several months before receiving funds from HMRC and this could impact cashflow and/or require a bridging loan. With regards to SDLT, this is due on the VAT inclusive amount. For example, on a purchase price of £5,000,000 the SDLT would be £239,500 but on a purchase price of £6,000,000 (£5m plus £1m VAT) the SDLT would be £289,500 i.e. an increase of £50,000. The purchaser may be able to recover the VAT, but the SDLT element is not recoverable.
There are certain rules, provisions, procedures and anti-avoidance measures to take into account when considering whether to opt to tax. In addition, the option to tax must be made on a timely basis; it cannot be backdated more than 30 days and should be made before any supplies of a particular property/piece of land are made so that VAT recovery is not jeopardised.
Mandatory standard rate
The freehold sale of a new (i.e. less than three years old) commercial building is liable to standard rate VAT without the seller having to opt to tax. The seller has to charge VAT on the sale and is therefore also allowed to recover VAT incurred on related costs, including construction. If the purchaser intends to rent the property out, it will need to opt to tax in order to recover the VAT incurred on the purchase price. It will then be required to charge and account for VAT on future rents. The various issues touched on above should be considered before opting.
Outside the scope of VAT – transfer of going concern (TOGC)
As noted above, sellers are normally required to charge and account for VAT when they sell a commercial property that they have opted to tax. However, if an opted property is sold with the benefit of an existing lease or sold with tenants in situ and the purchaser intends to continue letting the property to the existing tenants, the sale could qualify as the transfer of a going concern (TOGC) property rental business. In this case, the sale is outside the scope of VAT and no VAT is chargeable. Certain conditions must be met for a transaction to qualify as a TOGC, for example, if the seller is registered for VAT and has opted to tax the buyer must be in the same position by the date of the transfer. A VAT free TOGC is obviously an attractive option for buyers as there are no VAT cashflow issues and SDLT is minimised.
There are of course many other issues and scenarios that you could encounter in relation to commercial property transactions. The information above is for general guidance only and is not intended to replace or serve as advice for any specific transactions. Lewis Golden cannot be held responsible for any decisions made as a result of reading this article. We would strongly recommend that advice is taken, on a case by case basis, in relation to VAT and other tax issues.
If you would like any advice on this or any other VAT matters, please contact Dahlia Patsalides.