VAT on UK commercial property transactions

VAT is a tax which is calculated by reference to the value of taxable supplies of goods and services.

VAT is only ever chargeable on:

• a supply of goods or services;
• made in the United Kingdom;
• where it is a taxable supply;
• made by a taxable person;
• in the course or furtherance of any business carried on by him

but only so far as consideration is paid.

This guide only applies to commercial property and not to residential property.

Charging VAT on commercial property transactions

Goods or services: Most property transactions will self-evidently involve the supply of goods or services. However, a supply of services is deemed to include 'anything... done for a consideration'. This will apply to the grant of an option, entering into a restrictive covenant or the payment of a deposit to be held as agent for the seller.

In practice, whenever there is a consideration – whether or not this is in the form of money, for example exchanges of interest, and whether or not this is described as a reimbursement of costs - there will almost certainly be a supply which may attract VAT.

Made in the United Kingdom: Supplies in relation to land located outside the UK will not be subject to UK VAT.

Taxable supplies: Any supply of goods or services is 'taxable', unless the VAT legislation specifies that it is exempt. All taxable supplies are standard rated (20%), unless the VAT legislation specifies that it is zero rated.

Taxable Person: A taxable person is any company, individual, unincorporated association or partnership or trust which is registered or is liable to be registered for VAT.

Broadly, registration is compulsory where the taxable supplies that person has made in the last year, or in the next 30 days, exceed the VAT registration threshold – see HMRC's website.

These thresholds are always liable to catch large one-off transactions, such as property transactions, unless the sale or supply is exempt and not 'taxable'.

Business: A supply must be made in the course of business to attract VAT, even if made by a taxable person. However, 'business' is a very wide term – certainly wider than 'trading'. EU legislation uses the term 'economic activity'.

Who is liable for VAT?

VAT is the liability of the supplier of the goods or services – usually the seller or landlord in property transactions - rather than the person to whom the supply is made. Whenever the supplier makes a standard-rated or zero-rated supply, it must account to HM Revenue & Customs (HMRC) for VAT. Each quarter the supplier accounts to HMRC for that VAT. Large businesses may be required to make monthly payments on account.

Recovering VAT

When carrying on a business, VAT will also be chargeable on goods and services supplied to the business – this is known as 'input tax'. A business can recover this input tax if it is making taxable (whether standard or zero rated) supplies, but it cannot recover to the extent that it is making exempt supplies. A business can recover the VAT it has been charged – the input tax – by setting it off against the amount of VAT it has charged on the supplies that it has made – the output tax. This is done in the business' VAT return.

For a business only making taxable supplies, VAT on goods and services supplied to it is therefore only a cash flow problem. If the recipient of a supply is not a taxable person (for example, an individual acting in a personal capacity) or is making only exempt supplies (for example, a bank) the recipient cannot, generally, recover any VAT incurred on his costs. To such persons VAT on costs incurred is not a cash flow problem but an absolute cost.

VAT and property

Types of supply: Dealings in land can be standard rated, zero rated, exempt or even outside the scope of VAT depending on their nature.

Exempt supplies – general: Supplies of interests in, rights over or licences to occupy commercial property are in general exempt. The following supplies will be exempt:

• all leases, assignments, surrenders, reverse surrenders or licences to occupy any interest in land or buildings;
• sales of freehold commercial property or civil engineering works more than three years old or sales, leases or licences of all residential or charitable property.

Automatically standard-rated supplies of land: Some supplies are automatically standard-rated, such as:

• Sales of freehold or commercial land or a building or civil engineering work that in either case is less than three years old (from the date of completion) or is incomplete. Completion is the date of a certificate of practical completion, or the date the building is first occupied.
• Grants of miscellaneous interests in or rights over land or interests in land specified in the VAT legislation. This includes car parks, fishing rights, caravan pitches or call options to purchase automatically standard-rated land.

Note that an otherwise exempt supply can be converted into a standard-rated supply at the option of the supplier - see below.

Zero-rated supplies of land: Some supplies of land will be zero-rated, but this only applies to residential or charitable land and only in certain circumstances.

The supply of land will be zero-rated if it is the first grant of a major interest (that is, a freehold or a lease for longer than 21 years) of residential or charitable land that is either:

• newly constructed;
• converted from commercial to residential;
• renovated after being empty for 10 years; or
• a listed building that has been substantially reconstructed.

The option to tax

It is possible to choose to charge VAT on certain supplies of land that would ordinarily be exempt supplies; however, this is not possible for supplies of residential or charitable land. Suppliers will often choose to charge VAT so that they can recover VAT input tax incurred.

If a supplier chooses to charge VAT, it can only do so if it has elected to change the supply from 'exempt' to 'taxable'. Technically, the supplier must opt to tax and must do so before the date the supply takes place, notifying HMRC in writing of the option to tax within 30 days of the date that the option to tax becomes effective. Special rules apply that dictate the date of supply. If the supplier has made previous exempt supplies of the land, then it will need the prior approval of HMRC before it can opt to tax.

However, it is not always the case that property owners will elect to charge VAT. If they are letting or selling land to persons who cannot recover their VAT (for example, banks), these persons will generally prefer to purchase the land without VAT attaching. Electing to charge VAT can therefore restrict marketability of property.

It should be noted that once an option to tax is made it covers the entirety of a building. An option to tax binds all companies which are members of the same VAT group at the time of the option, or members who join the VAT group at a later date while the original company that made the option still has an interest in the land.

An option to tax can be revoked within six months of being made, provided no supplies of the land have since been made and subject to certain other conditions. After that, an option to tax can only be revoked after 20 years, except in limited circumstances where the building is demolished. One person's option to tax is not relevant to another owner of a different interest in the same land, so just because the landlord has opted to tax does not mean that the tenant has to charge VAT if it grants a sublease.

An option to tax can be disapplied by HMRC under various anti tax-avoidance provisions.

Capital Goods Scheme

It is important to note the effect of the Capital Goods Scheme in property transactions. This allows a supplier to make adjustments, over several years, to how much input tax it originally reclaimed on the asset in certain circumstances.

This scheme applies in broad terms to the acquisition of, or alteration or extension of, commercial property costing more than £250,000. Where input tax has been recovered, the effect of this scheme needs to be carefully considered.

Where a property is within the Capital Goods Scheme, then the use to which that property is put must be monitored over a 10-year period and where the initial use to which that property is put varies, whether by changing the use from exempt purposes to taxable purposes or vice versa, then an adjustment is made to the landowner's entitlement to recover VAT.

For example, if a company buys land for £10 million from a seller who has elected to charge VAT, then £2 million will also be payable as VAT. If the company uses the land entirely for making taxable supplies, then the whole of that £2 million is recoverable as input tax at the end of the first VAT period following the purchase. The percentage of taxable use has to be monitored, and any decrease in the percentage could create a VAT charge. If, you example, at the end of year five the company decides to use the land entirely for an exempt purpose, then the company would have to pay £1 million back over five years to HMRC.

What a business does can therefore have an effect on VAT which was recovered up to 10 years ago.

Transfers of Going Concerns (outside the scope of VAT)

The sale of assets together which are capable of being run as a business (a 'going concern') to someone who intends to use those assets for carrying on the same type of business will be treated as a Transfer of a Going Concern (TOGC) and so be outside the scope of VAT.

The sale of property can be a TOGC if:

• it is transferred as part of the sale of a whole business; or
• the property is a business in its own right (for example, an investment business where the land generates a rental income).

The sale of a let commercial property, or the assignment of a headlease, amounts to the transfer of a business as a going concern for VAT purposes. No VAT is charged on such transactions, providing all the criteria for TOGC treatment are present. If the seller has opted to tax in respect of the property or the property in question is standard rated then the purchaser must also opt to tax and notify HMRC in writing of that option to tax prior to the date of supply. Failure to do this will mean that the transaction is not a TOGC, and that VAT is therefore chargeable.

It is the seller's responsibility to ensure the correct VAT treatment. If VAT is not charged when it is due, then the seller could be subject to interest and penalties. If VAT is charged when it is not due then the purchaser would be unable to recover it as it would not be tax lawfully due.

In summary, TOGC relief will apply where:

• a taxable person transfers assets as a business (or part of a business) as a going concern, to a transferee who is registered for VAT (or who will immediately become registerable as a result of the transfer);
• the transferee intends to use the assets for the same business as the transferor;
• in the case of land and buildings, if the transfer would be standard rated but for TOGC relief, then the transferee must have opted to tax (and notified HMRC of that option) before the relevant time.

An additional requirement is that the purchaser must notify the seller that the purchaser will not have his option to tax disapplied for being part of a particular tax avoidance scheme.