Since the introduction of VAT in the UK in 1973, business owners and their advisers have come to appreciate that this tax is complex and may have far reaching consequences in many business transactions not least in those involving property.
In view of that, careful consideration should be given to the issue of VAT at the outset of any deal involving property, and businesses should ensure they seek the appropriate advice at all stages of a particular transaction to reduce the risk of being caught out by matters that could adversely affect the profitability of a deal.
Legal advisers and businesses operating in the property sector should be aware of recent changes in UK VAT legislation introduced on June 1st this year to Schedule 10 of the VAT Act 1994. These changes can be seen as an attempt by the Government to simplify this complex area and have brought about some welcome changes to the system of VAT and property. Despite this, the issue is still capable of posing a problem for businesses which fail to seek appropriate advice and fully understand their obligations in this area.
VAT & property
VAT is a tax imposed on the sale price of goods and services. Where a business is registered for VAT and sells or supplies something, they collect the VAT from the customer or client and then pass that sum onto HM Revenue and Customs (HMRC). The amount passed on to HMRC is however reduced by the amount of input tax that a company has suffered i.e. the amount of VAT that the company has paid for goods purchased by it.
Specifically regarding property, the VAT treatment will depend upon the nature of the transaction. Generally, the sale of commercial land and buildings will be exempt, except where the commercial premises being sold are less than three years old or where the seller takes the decision to waive the VAT exemption otherwise known as the seller ‘opting to tax’.
The granting or assignment of a lease is treated in the same manner and will be exempt subject to the landlord’s decision to ‘opt to tax’.
Prior to the introduction of the option to tax on August 1st 1989, the courts determined it was unlawful for businesses to zero rate the construction and re-development costs of commercial property, meaning companies engaging in the construction or redevelopment of commercial buildings would have to pay VAT on the costs of acquisition and construction, without the ability to offset that. This problem has largely been overcome by the option to tax facility. By opting to tax, the commercial owner is able to convert what would otherwise be an exempt supply into a standard rated supply so that a developer can recover the tax incurred on the acquisition and development costs.
The key advantage to the option to tax is clear and could mean that where businesses are able to recover VAT on related costs, it can significantly improve the profitability of a property deal. Further, the option is a decision to be taken solely by the seller or landlord and it can be made on a building by building basis.
That said, disadvantages of the option do exist. Namely, once a property has been elected, it cannot be revoked for 20 years. In addition, it is not possible to opt to tax certain properties (i.e. those used for residential purposes) and in some circumstances, it is necessary to ask HMRC’s permission before opting.
Commercially, landlords and vendors should be aware that by opting to tax a building, certain buyers or tenants may be discouraged. For example, those not registered for VAT or those who are not able to recover VAT such as banks, building societies and insurance companies would be hard hit by a landlord or seller opting to tax.
The main problem surrounding VAT and property arises in practice because the rules are often misunderstood. Businesses should be aware that opting to tax is a two stage process. Firstly, the vendor or landlord should decide whether to opt to tax. Bear in mind that it may not always be necessary to opt to tax. For example, where VAT was not charged on acquisition or where no development or construction is planned there may be little need to opt to tax. Secondly, in order to make it legally valid, it is necessary to notify HMRC’s Option to Tax Unit in Glasgow within 30 days of the decision.
Failure to correctly opt to tax buildings can lead to disputes arising on two fronts. Firstly with the tenant or purchaser, who may upon identifying that an option to tax a particular building was ineffective, take action to reclaim VAT unlawfully charged or secondly with HMRC who may take action to pursue VAT wrongly reclaimed plus interest and penalties. A worrying point to note is that often large businesses have no reliable record of which properties they have opted to tax and therefore they are leaving themselves open to the possibility of disputes arising.