The nationwide lockdowns may have forced a slowdown in the movement of people, but the raft of changes to property tax shows no sign of abating. Sarah Cardew looks at the detail.
There have been several interesting VAT changes suddenly introduced for the property sector, and surprisingly, with retrospective effect. This is in addition to the VAT changes for the construction sector that are due to come into force on 1 March 2021, and which will place an additional compliance burden on those businesses within the sector. Considering that the country is in the midst of a pandemic, this might seem surprising.
We understand that various industry bodies are currently lobbying the government to re-examine these changes. However, in the meantime, we consider the detail.
Retrospective change for VAT on compensation payments
Compensation payments have normally been treated as outside the scope of VAT. However, recent consideration of compensation payments by the UK courts and the European Court of Justice has resulted in such payments being treated VATable.
HMRC guidance on charges described as compensation or early termination fees in a contract has been changed to reflect the position now adopted by the courts. This guidance makes it clear that these payments are now generally liable to VAT. This updated guidance was published in HMRC’s Business Brief 12/20 (2 September 2020).
Controversially, HMRC advises that any VATable person who has failed to account to HMRC for VAT on such fees must now correct their error as soon as possible. This makes this change retrospective and places a compliance burden on those in the real estate sector.
At present, we do not know how far HMRC could look back, but we would advise checking transactions over at least the past four years. Any amount payable as a result of a termination provision could be caught, irrespective of when that clause was entered into. So an agreement could have been entered into 10 years ago but only just have been exercised (or not at all yet).
Given that it is very difficult to obtain a ruling from HMRC and that the guidance overrides existing rulings we may have obtained for future payments, we can no longer rely on the current guidance.
Industry bodies are rightly concerned about the retrospective effect of this updated guidance, which is a departure from the normal position when a VAT change applies going forward only – and this has caused some debate. The new VAT guidance came in in September but has been largely under the radar to date.
It is also worrying that it might not be limited to VAT and could represent a change of direction for the government as it seeks to recoup revenue after the pandemic.
We understand that HMRC is in the course of significant litigation on this topic based on rulings given by the European Court of Justice. It has also received counsel’s advice, and this new guidance is the result of that.
While HMRC does accept that certain payments may still be considered to be true compensation and therefore outside the scope of VAT, it also argues that such payments are often called compensation when they are in fact payment for a supply. Therefore, it is now very important to ensure that the drafting of compensation clauses reflects the true intentions of the parties, and that VAT advice is received at the outset.
If you have a specific ruling from HMRC saying that fees are outside the scope of VAT, you only have to account for VAT on such fees received after the issue of this announcement (contained in Business Brief 12/20).
Dilapidation payments
In the past, true dilapidations payments were considered to be compensation which fell outside the scope of VAT. Dilapidations payments now present a worrying conundrum, and it will be very important to be able to demonstrate that the payment was a pure dilapidations payment.
The previous HMRC guidance was that break payments did not attract VAT either. However, it seems that HMRC now considers that they do attract VAT, due to the Vodafone case (see below), and change in guidance.
The ECJ could refer to Vodafone Portugal v Autoridade Tributária e Aduaneira [C-43/19 (11/6/2020)], to reinterpret the intentions of the parties. In Vodafone, the ECJ ruled that an amount payable in the event of early termination of a contract should be considered to be an integral part of the price that the customer committed to pay to the provider to fulfil its contractual obligations. Only where there was no direct link between a payment and a supply of goods or services would it fall outside the scope of VAT.
If a business has paid a dilapidations payment inclusive of VAT, depending on the wording of the clause, it could try reclaiming 20% from the recipient.
As stated earlier, this could potentially be as a result of the government’s efforts in recouping revenue after the pandemic. However, from the taxpayer’s and business owner’s perspective, HMRC could not have chosen a worse time given the pandemic and a number of contracts have already been terminated. The impact of this change on business owners is likely to be substantial.
VAT for the construction sector
HMRC has also published new guidance on the VAT reverse charge for those who buy or sell construction services. These changes are designed to combat VAT fraud in the construction sector and could have a great impact on a business’s VAT compliance burden and cashflow.
The changes were originally due to already be in force, but have been delayed until 1 March 2021 due to Covid-19. However, businesses must prepare and ensure that they have appropriate systems in place to cope with the demands of the reverse charge system.
Broadly, the reverse charge means that a customer receiving a supply of construction services will have to pay the VAT direct to HMRC rather than paying it to the supplier. Any construction business that meets the following conditions will need to use the reverse charge from 2021:
- their customer is registered for VAT in the UK;
- payment for the supply is reported within the Construction Industry Scheme;
- the services supplied are standard or zero rated for VAT;
- the business is not an employment business that supplies either staff or workers or both; or
- the customer has not given written confirmation that they are an end user or intermediate supplier.
So a construction business is going to need to check both a customer’s VAT and CIS numbers, and will need to develop systems to cope with this.
The construction services covered by the reverse charge are those falling within the definition of “construction operations” in the CIS. This is a wide definition and includes the construction, alteration, repair, extension, and demolition of buildings, and the dismantling of buildings or structures and infrastructure, such as roads, railways and waterways. It also includes painting and decorating. Specific services are excluded, including the professional services of architects, surveyors and certain consultants.
The reverse charge will not apply to recruitment businesses that supply construction workers. The difference between supplying staff and supplying construction services is that the individual workers are employed or paid by the recruitment business and not by the construction business that used them to provide the construction services.
There will be certain supplies that will be exempt from the reverse charge as long as the customer has notified the supplier that an exemption applies. These are:
- supplies of construction services made to end users: an end user is a customer that has to report its payments for specified supplies through CIS, but does not make supplies of construction services itself;
- supplies of construction services between group companies: this will only apply where the customer is an end user and the supplier is part of that customer’s corporate group; and
- supplies of construction services between landlords and tenants.
We would recommend that a business reviews all of its contracts to see whether the reverse charge applies and tell its customers accordingly. This could be a tedious process and one that is best started now.
Customers will also need to tell their suppliers whether they are an end user or an intermediate supplier. Importantly, a business will need to work out how to record the reverse charge in its accounts and therefore its accountants must be involved early on.
What about other property taxes?
Readers will be aware of the reduced rates of stamp duty land tax that were announced to great fanfare on 8 July 2020. The reduced rates applied with immediate effect to residential property transactions completing on or before 31 March 2021, whether the purchase was liable at the standard rate or higher rate of SDLT.
Due to the surge in property purchases needing to complete before the deadline, there are now, inevitably, calls on the government to extend the reduction. Property bodies are writing to the chancellor in the hope that he will answer their calls for an extension.
However, the government is surely going to be under pressure to recoup cash as the country slowly recovers from Covid-19, and the collection of tax is one way of doing that.
Our current advice would be to push through residential property transactions as efficiently as possible because an extension of that 31 March 2021 deadline cannot be taken for granted.
Sarah Cardew is a partner and head of tax at Irwin Mitchell LLP
