VAT on UK commercial property transactions

VAT is often recoverable for businesses and therefore is not an absolute cost. However, VAT charged as part of a commercial property transaction may be irrecoverable and can impact the value of returns from the transaction.

UK VAT is only ever chargeable on:

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

but only so far as consideration is paid.

The UK VAT system is based on EU law and EU member states will have similar VAT systems.

This guide only applies to UK VAT on commercial property and not to residential property.

Charging VAT on commercial property transactions

Goods or services

Most property transactions will involve the supply of goods or services. However, for VAT purposes a supply of services is deemed to include "anything... done for a consideration". In a property context, a supply will include a 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 there will almost certainly be a supply which may attract VAT. The consideration does not need to be in cash and can include exchanges of interest, including those not described as a reimbursement of costs.

Made in the United Kingdom

For a supply to be chargeable to UK VAT it must be made in the UK. In a property context, this means that the property must be in the UK.

Supplies of land located outside the UK will not be subject to UK VAT, although they may be subject to VAT in another jurisdiction.

Taxable supplies

A 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 subject to a lower rate. Certain supplies are zero rated, which means that no VAT is payable, although it is stated as being chargeable at 0%.

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 (currently £85,000, although this threshold is reviewed annually).

These thresholds are set at a level that will catch large one-off transactions, such as property transactions, unless the sale or supply is exempt and not taxable.

In the course of a business

A supply must be made in the course of a business to attract VAT, even if made by a taxable person. The term "business" is widely defined and extends beyond "trading". EU legislation uses the term "economic activity".

Who is liable for VAT?

The supplier of the goods or services is liable to account to HM Revenue & Customs (HMRC) for VAT. This is usually the seller or landlord in property transactions, rather than the person to whom the supply is made. Whenever the supplier makes a VATable supply, it must account to HMRC.

Recovering VAT

Whilst a business may be required to account to HMRC for VAT charged on supplies that it makes, it may also incur VAT on goods and services that it receives. This VAT is known as ‘input tax’. A business can recover input tax if it is making taxable supplies, including where supplies are zero rated. However, a business cannot recover input tax to the extent that it is making exempt supplies for VAT purposes.

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). A business will claim its recovery of VAT through its VAT return that it submits to HMRC.

A business that only makes taxable supplies should be able to fully recover input VAT that it is charged on goods and services that it receives. Here, VAT would not be an 'absolute' cost to the business and may only create a cash flow problem, assuming input tax needs to be paid to HMRC before output tax has been charged on supplies that the business makes, VAT that it is charged on goods and services supplied to it only creates a cash flow problem and is not an absolute cost. However, 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 output VAT incurred on supplies it receives. In these circumstances, VAT input tax will be  an absolute cost.

VAT and property

Typically, 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 generally exempt. The following supplies will be exempt:

• all leases, assignments, surrenders, reverse surrenders or licences to occupy any interest in land or buildings; and
• 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.

It should be noted that an otherwise exempt supply can be converted into a standard-rated supply at the option of the supplier and is known as an “option to tax”. This is discussed further 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 (“opt”) to charge VAT on certain supplies of land that would ordinarily be exempt supplies and not chargeable to VAT. However, an option to tax cannot be made in respect of 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 the supply. If the supplier has made previous exempt supplies of the land, then it will need prior approval from HMRC before it can opt to tax.

Notwithstanding the benefits of “opting” to charge tax on a property transaction, the seller/property owner may not always elect to charge VAT. If they are letting or selling land to persons who cannot recover the VAT charged - for example, banks, who largely make exempt supplies - these persons will generally prefer to purchase the land without incurring VAT. Therefore, it is possible that electing to charge VAT on a property can restrict the future market value of the property.

Where an option to tax is made, it will cover 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, and members which subsequently join the VAT group, if the original company that made the option continues to have an interest in the land.

Subject to certain conditions, including that no supplies of the land have since been made, an option to tax can be revoked within six months of being made. After this period, except for in limited circumstances where the building is demolished, an option to tax can only be revoked after 20 years. One person's option to tax does not extend to another owner of a different interest in the same land: for example, where a landlord has opted to tax, the tenant does not have to charge VAT on the grant of a sublease.

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

Capital Goods Scheme

It is important to consider the impact of the Capital Goods Scheme (CGS) in property transactions. In certain circumstances, the CGS requires a supplier to make adjustments to how much input tax it originally reclaimed on the asset. The adjustments are made over several years.

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

Where a property is within the CGS, the use of the property must be monitored for a 10-year period. Where the initial use is varied, whether by changing the use from exempt purposes to taxable purposes or vice versa, 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 which has elected to charge VAT, then £2m (assuming a 20% VAT rate) will also be payable as VAT. If the company uses the land entirely for making taxable supplies, the whole of that £2m is recoverable as input tax at the end of the first VAT period following the purchase. The percentage of the land used for taxable purposes then needs to be monitored, as any decrease in the percentage could create a VAT charge. For example, if 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 £1m back over five years to HMRC.

What a business does can impact 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 (as a 'going concern') to someone who intends to use those assets for carrying on the same type of business may be treated as a transfer of a going concern (TOGC) and so be outside the scope of VAT.

Broadly, the sale of property may 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.

Provided all the criteria for TOGC treatment are met, no VAT is charged on a TOGC. 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 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; and
• 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.