VAT in connection with commercial property is a complex area. There is a lot to consider and there is a substantial amount of case law to draw upon. Below is a brief summary of some of the key VAT aspects to be aware of if you are purchasing or leasing commercial property.
In general, there are four main issues to think about for VAT purposes:
What is VAT Exempt?
The sale or lease of a commercial property is generally exempt from VAT. If so, the purchaser or tenant does not have to pay VAT. That may be very good overall, however, when a vendor or landlord makes an exempt supply of a property, they are unable to recover VAT incurred on related costs. These can be significant.
Option to Tax VAT
Commercial property owners can opt to charge VAT at the standard rate (currently 20%) when selling or leasing their property. When a vendor or landlord opts to tax a property, they must usually charge VAT on all supplies they make relating to that property. Therefore, they must charge VAT on the sale or rentals. However, the landlord can also recover VAT charged to them on costs related to the property. Opting to tax can provide a real advantage in the right circumstances, for example, where substantial refurbishment costs may have been incurred.
Opting to tax is not always appropriate as some businesses are unable to recover VAT incurred on costs. These are VAT adverse businesses and include businesses in financial, insurance, health, welfare and charitable sectors. Therefore, consideration of the market sector of potential purchasers or tenants is essential before a decision is taken to opt to tax.
An option to tax must be notified to HMRC in writing. It is almost irrevocable and is only revocable in very few circumstances. Making the right long term decision is obviously critical.
The option does not follow the property and the next purchaser or tenant will need to make their own option depending on their individual circumstances. Consequently, at the time of considering the purchase or rental of a commercial property, opting to tax should be considered carefully.
Transfer of Going Concern
The third issue is if there is a Transfer of Going Concern (TOGC). Where an opted property is sold with tenants in place or with the benefit of an existing lease, the vendor would normally be required to charge VAT at the standard rate. However, if the prospective owner intends to continue to let the property to the tenants then, subject to certain conditions, the transfer is a TOGC and no VAT is charged on the purchase price. This is clearly attractive for most buyers in these circumstances.
Sale of ‘new’ Commercial Property
The fourth issue is the sale of ‘new’ commercial property. Such will be liable to VAT at the standard rate. A property is ‘new’ for these purposes if it is less than three years old. A purchaser of new commercial property to rent out is likely to choose an opt to tax in order to be able to recover the VAT charged on acquisition. Once opted, they will be required to charge and account for VAT on the rents going forward and on a future sale of the property, unless it qualifies as a TOGC.
With increasing property values and punitive HMRC penalties in the case of non compliance, VAT mistakes can be very expensive. Getting the appropriate advice at the outset is important and our VAT team can guide you through that process.
Option to Tax
The option to tax is a mechanism which allows, what would otherwise be VAT exempt supplies of land and commercial property, to become taxable supplies. This allows VAT recovery on property related costs. An option to tax cannot be made over residential property. Once land/property is opted to tax, VAT is chargeable on all future rental and sale of that land/property. By opting to charge VAT on rents and sales income, landlords can then avoid irrecoverable VAT on related costs. There are a number of anti-avoidance measures which can disapply an option to tax. These rules are complex and advice should always be taken when deciding on whether to opt to tax as this can impact upon the future marketability of that property.
The option to tax process is a two step approach. The first step is to make the decision to opt and document that decision (in a Board Minute for example) and the second step is to notify HMRC in writing within 30 days of the decision (please note that the current deadline is 90 days due to Covid-19). The option to tax is made on form 1614A which should then be emailed to the Option to Tax Unit of HMRC. HMRC will issue an acknowledgement in due course. If the business has previously made exempt supplies of the property, then permission to opt to tax is needed before the option to tax can be made. There are a number of automatic permissions which are detailed in HMRC’s Notice 742A.
If an opted property is sold, VAT will be due on the sale price (unless transfer of going concern treatment applies). Stamp Duty land tax will be calculated on the VAT inclusive price.
Commercial landlords and service charges
Under the terms of a lease, commercial landlords will typically charge tenants for rent plus a service charge (sometimes known as additional rent or maintenance charge). The basic rule is that a mandatory service charge for upkeep of the building as a whole (e.g. repair and maintenance) will follow the VAT liability of the lease itself, so either VAT exempt or subject to VAT if the property is opted to tax.
However, other separate charges may be made by landlords to tenants for insurance, electricity, light and heating etc. If the landlord is the insured party, any charge made to the tenant follows the main supply of the accommodation. However, if the tenant is the insured party, any charge paid by the landlord on the tenants behalf is a disbursement which is outside the scope of VAT.
Unmetered supplies of gas and electricity form part of the main supply of accommodation. Where secondary meters are in place for tenants use of gas and electricity, this is a separate supply to the accommodation and as such, any charges will be liable to VAT at either the standard or reduced rate (depending upon the level of use).
Whatever the transaction VAT audit advice is essential at the outset. Please contact us for further information.