On 12 May, HMRC published a consultation on simplifying the land and property value added tax exemption.
Under current rules, the starting point is that a supply of land is exempt from VAT. This means that the supplier of land is not required to charge VAT in addition to the consideration paid by a recipient. However, in making an exempt supply, the supplier will not be able to recover VAT paid on the costs of making that supply, with the result that such VAT (including VAT on acquisition and construction costs of the property) becomes an absolute cost.
In relation to non-residential property, the supplier has discretion to apply VAT at the standard rate to its supplies by “opting to tax” a property. In doing so it will be required to charge VAT on the supplies it makes but it can recover the VAT it pays on its associated costs.
In relation to residential and charitable properties, there are one-off “zero-rating” rules.
Why a consultation?
In its 2017 report VAT: routes to simplification, the Office of Tax Simplification recommended changes to the VAT regime, and Brexit has given the UK greater autonomy to amend VAT legislation (no longer constrained by the requirement to follow EU VAT directives).
The consultation document acknowledges that VAT rules are very complex: there are 15 exceptions to the VAT land exemption, with 26 notes of interpretation to those exceptions. And this is apart from any consideration of the detailed option to tax and zero-rating rules.
The rules present real difficulty for businesses, and misunderstandings are common. Furthermore, as business models develop and adapt, the VAT rules struggle to keep pace, with a common issue now being the distinction between a supply of land (potentially exempt)
and a supply of facilities (always subject to VAT).
Widely drafted anti-avoidance legislation can compound the difficulties faced by taxpayers, and with no central database to check whether a property has been opted to tax, trying to establish the VAT status of a property can be time-consuming and costly.
Proposals
HMRC has set out six possible alternative models for the VAT regime:
A. Remove the ability to opt to tax property and make all relevant property transactions VAT-exempt;
B. Remove the option to tax but make all land and property taxable at a reduced rate;
C. Make all commercial land and property taxable at the standard rate with an option to exempt;
D. Provide that all supplies of short-term or minor interests are subject to VAT at the standard rate;
E. Make most supplies subject to VAT at the standard rate and exempt only specific supplies (such as supplies of residential property); or
F. Link the VAT liability to whether the property is registered at the Land Registry.
The consultation document requests proposals for alternative suggestions to these models.
Could these proposals be workable?
Given that the first three models (A, B and C) were rejected by the OTS in its 2017 report, it seems unlikely that they will now be taken forward.
Model D provides an interesting solution to the increased difficulty of distinguishing between supplies of land and supplies of facilities, in that both would become taxable at the same rate. But this proposal leaves unanswered the question of who will bear the additional cost where the property is residential; will consumers be required to meet the new VAT liability or will developers/landlords meet the cost, thus reducing profits? Neither seems viable, and this is the reason that model B was rejected by the OTS (and that was on the basis of a reduced VAT rate).
Model F appears to solve the specific problem of there being no central database, but does not appear to address wider concerns raised.
Model E appears to be the most reflective of HMRC’s current approach of seeking to narrow the existing VAT exemption and is possibly the most likely model to be developed. Such a change could significantly simplify VAT legislation, with the option to tax and its associated anti-avoidance legislation becoming redundant while retaining the VAT exemption for residential property. However, we would advocate that zero-rating for new-build residential construction needs to be retained.
Nonetheless, there will be taxpayers who suffer, in particular taxpayers who operate VAT-exempt businesses or occupy for non-business purposes. There are those who would also wish to retain the flexibility of the current system notwithstanding its complexities.
An alternative approach
Any act of substantially overhauling the existing VAT regime will be problematic and so an alternative approach could be to simply improve existing rules.
The legislation is overly complex, but the structure of the regime is familiar to those working within the real estate sector. The rules would remain a challenge for those outside the property industry, but simplification and improvement could be brought about by a focus on some of the key failings:
- the option to tax anti-avoidance legislation could be simplified, with clarification added that it applies only to incidences of actual tax avoidance and not innocent transactions;
- the interaction between property transactions and the Capital Goods Scheme could be reviewed to ensure that taxpayers do not inadvertently trigger significant liabilities as a consequence of their property dealings;
- a mechanism or process could be created for dealing with situations where parties are unsure whether an option to tax has been made;
- a single tax definition of “dwelling” should be introduced, applicable across all taxes for clarity (and, in particular, the VAT rules’ reliance on planning law concepts should be severed);
- the scope of zero-rating of charitable buildings should be clarified and broadened to other buildings of public benefit; and
- removing the “tax on a tax” by which stamp duty land tax is applied to the VAT-inclusive purchase price for property. This element of double taxation regularly distorts behaviours and adds complexity to property transactions.
Daniel Kennedy is a partner and Daniela Porco is a trainee in the tax department at Shoosmiths LLP
The deadline to respond to the consultation – Simplifying the VAT Land Exemption – is 3 August. Responses can be sent to landsimplification@hmrc.gov.uk is 3 August 2021, and responses can be sent to: landsimplification@hmrc.gov.uk
