This is an extremely complex area of VAT and one that requires a close attention to detail as well as ones that receives close scrutiny from HMRC.
The starting position is that for most transactions involving the sale or letting of commercial property the VAT treatment is VAT exempt. The exception to this is that the freehold sale of a commercial property within three years of its construction is automatically liable to VAT at the standard rate of the tax (currently 20%). In addition specific types of letting activities are also standard rated – e.g. car parking, charges for storage.
The usual implication of a VAT exempt property transaction is that it carries no entitlement or obligation to register for VAT as it is not a taxable business activity. In turn this also means that any VAT incurred on any associated costs such as the purchase or development of the property cannot be recovered from HMRC and so has to be accepted as a cost.
To sweeten the pill here the option to tax was introduced so that property owners and landlords could use the land and buildings for the purposes of making taxable supplies for VAT purposes and so register for VAT and thereby recover the VAT on any associated costs. The effect of opting to tax is that the supplies of the land/buildings concerned are liable to VAT at the standard rate.
Opting to tax would only usually be recommended where there are significant amounts of VAT involved because once taken the option to tax has to remain in place for a period of at least twenty years. This means that any transactions within that twenty year period would be subject to VAT unless the option to tax is covered by specific exclusions. This has the effect that future tenants or prospective purchasers may not be attracted by a rent or sale price that carries an additional cost in terms of VAT. This can be a particular problem for those organisations in the health, education and charity sectors as well those involved in the provision of financial services or insurance services.
An option to tax will come up frequently where commercial properties are bought or sold under the transfer of a business as a going concern (TOGC) provisions. These transactions will involve the transfer of commercial property letting businesses activities and there are special rules in place which allow an opted property to be transferred as outside the scope of VAT rather than subject to VAT at the standard rate. The option to tax does not flow with the property and one of the TOGC conditions is that the buyer must also opt to tax the property within certain time limits so that the rent received after the transfer continues to be chargeable to VAT. Although opting to tax does place additional constraints on the buyer it will generally be a good idea because if the purchase of the building is outside the scope of VAT there is a double benefit for the buyer:
- The Stamp Duty Land Tax payable on the transaction will be reduced as it is based on the total price paid and will include the VAT element where VAT is chargeable; and
- There is a cash flow benefit in that the buyer does not have to pay VAT and then wait to recover it from HMRC through a VAT return.
In other instances the sale of opted commercial property will carry VAT and it will be important for the buyer to exercise an option to tax, be VAT registered and have a timely VAT return in order to recover the VAT promptly.
A great deal of care is needed with the option to tax as there are certain situations where an option can be disapplied. In this scenario the supply of the property, whether a sale or a letting, cannot be standard rated and will revert to being VAT exempt. The knock-on effect can be that the supplier then has to revisit his initial VAT recovery and make adjustments to the VAT already recovered from HMRC.
Commercial property transactions will by their nature involve significant sums and therefore carry a significant VAT cost if they are not treated correctly. Add to this a penalty regime where the penalty imposed is based on a percentage of the VAT at stake means that there can be a particularly nasty surprise in getting it wrong. In any property transaction the recommendation is always to take advice on the VAT implications at the outset to ensure that VAT is accounted for correctly
The advice given in this summary is only an overview of the VAT regulations. If any further information or advice on a specific transaction is required please contact Andy Branson at Albert Goodman LLP.