Alex Barnes highlights some of the VAT pitfalls to be avoided when making a supply of property
Nobody likes paying value added tax (VAT) and getting the VAT position wrong on a transaction can be very costly.
The standard rate of VAT is 20% and on larger transactions it can be a big liability. Even when the VAT is recoverable it usually creates a cashflow cost and, in most circumstances, an additional stamp duty land tax (SDLT) cost, as SDLT is payable on VAT. It is, however, possible with forethought and preparation to identify the VAT problems that people often encounter – as well as ways to avoid them.
Failing to opt to tax
Failing to make an option to tax on the disposal or letting of secondhand commercial property will prevent the seller/grantor from recovering VAT incurred in connection with the sale or letting of it, and could also result in a clawback of VAT previously recovered.
An option to tax is often forgotten where an owner-occupier business sells property. The business may have been recovering VAT based on the fact that it makes only taxable supplies and, for this reason, such businesses sometimes fail to consider the need to opt to tax their property before sale. Even if the property is being sold as part of a transfer of a going concern (TOGC), the seller should still consider opting to tax it before sale to avoid any adverse VAT issues. Opting to tax may not actually create a VAT liability for the purchaser if the sale can be a TOGC, and in these circumstances there would be no additional SDLT.
However, making an option to tax is not a panacea and, in certain circumstances, not opting to tax may be advisable, for example, if the sale or letting is to someone that cannot recover VAT (such as a bank or insurance company). In those circumstances the seller should still understand the implications of not opting and ultimately, if it decides not to opt, it should consider whether to include in the sale price any VAT costs incurred as a result.
Anyone making a supply of property should always consider whether to opt to tax it before making the supply.
Disapplication of an option to tax
Having made an option to tax, do not be fooled into thinking that everything from a VAT perspective is fine on the letting of property. In certain circumstances a tenant can disapply a landlord’s option to tax, which can result in irrecoverable VAT for the landlord together with a possible clawback of VAT previously recovered. Once the option has been disapplied a landlord cannot simply make another option to resolve the problem.
This issue is often encountered when a letting is made to a tenant that is not fully taxable and the tenant contributes to the landlord’s works, possibly because the tenant wants a higher specification and the landlord does not want to fund such works. This can be avoided by requiring the tenant to engage a third-party contractor to do the works, or by making sure that the contribution is dealt with by way of a lease premium or rent paid on or after the grant of the lease.
Another circumstance in which the option can be disapplied is where a bank is lending money to the landlord to finance the development and is also coincidentally intending to occupy the property. Different divisions of the relevant bank may be completely unaware of each other’s activities. This issue can be avoided by a making sure the landlord understands whether there is any link between its funders and any proposed bank tenant.
Faulty TOGCs
More and more properties are being acquired by new special purpose vehicles (SPVs) set up purely to acquire the relevant building. In most cases the SPV is not registered for VAT at the point of completion of the property acquisition.
If the SPV wants its purchase to be a TOGC and the seller is VAT registered, the SPV must either be VAT registered or be liable to be VAT registered. If the SPV is not VAT registered or liable to be VAT registered on completion of the property acquisition, there can also be no VAT payable on the acquisition and additional SDLT on the VAT. The VAT might only result in a cashflow cost but the SDLT will be a real cost and, on a commercial property acquired for, say, £25m plus VAT, the additional SDLT will be £200,000.
The VAT status of the SPV should be considered at the commencement of a transaction to ensure it is not ultimately delayed owing to VAT registration issues of the SPV.
Conversion from office to residential
It is possible on the conversion of an office to residential property that a purchaser can disapply the seller’s option to tax. The purchaser can do this unilaterally at any point before a taxable supply is made of the relevant property by the seller.
Many purchasers initially think this is a good result, as it means no VAT will be charged on the purchase price and SDLT will be saved. If, however, the purchaser can recover any VAT charged to it because of the nature of the supplies it intends to make of the developed property, the actual saving could simply be a cashflow saving and SDLT on the VAT (that would otherwise be charged).
The position of the seller on such a transaction can be complicated from a VAT perspective and should always be considered by a purchaser before seeking to disapply the option to tax. If the seller’s option to tax is disapplied it will incur irrecoverable VAT in connection with the sale and, more seriously, it could incur a clawback of VAT previously recovered. A well-advised seller could seek to add these costs to the purchase price and, having done this, the cost to the purchaser could be greater than if it had not disapplied the seller’s option to tax. The purchaser should discuss this issue with the seller before seeking to disapply any option.
Paying third-party fees
Often when a tenant asks the landlord for consent to do something the landlord will only agree to this if the tenant agrees to pay the landlord’s legal fees.
The landlord’s legal adviser should invoice the landlord but more often than not it invoices the tenant. On the basis that the legal adviser has not made a supply (for VAT purposes) to the tenant it cannot charge VAT to the tenant. If a tenant was to pay a sum wrongly claimed as VAT then technically HM Revenue & Customs (HMRC) could (and sometimes does) refuse to allow the tenant to recover this “VAT”, even though HMRC may not be out of pocket in allowing it to do so.
The correct approach is for the landlord’s solicitor to invoice the landlord and for the landlord to invoice the tenant. Assuming the landlord has opted to tax it will be able to recover the VAT charged to it and should charge VAT to the tenant in addition to the VAT-exclusive sum invoiced by the legal adviser. Assuming the tenant is using the property to make VAT-able supplies, the tenant should be able to recover the VAT charged to it and none of the parties are therefore out of pocket from a VAT perspective.
Tenants should not agree to pay landlords’ legal costs if these include VAT unless the tenant receives a VAT invoice from the landlord.
Top tips
- Owner-occupiers should always consider whether to opt to tax before selling property or granting any interest in, or over, it
- When a tenant proposes to make a contribution towards a landlord’s works, always check whether this will cause the landlord’s option to be disapplied
- When letting to a bank always double check whether it is connected to any funder funding the development of the property
- On a TOGC, if the purchaser is not registered for VAT, always consider whether it is liable to be registered for VAT as a result of the acquisition and, if not, get it registered pre-completion
- On residential conversions, do not automatically disapply the seller’s option to tax without considering the VAT implications to the seller of such action
- Tenants should not agree to pay the VAT on landlords’ legal fees unless they receive a valid VAT invoice from the landlord.
Alex Barnes is a partner and head of the tax advisory team at Irwin Mitchell
