VAT and property

A sale or lease of UK land is generally exempt from VAT. However, commercial property owners can opt to charge VAT when selling or leasing their property to enable them to recover the VAT costs associated with construction or development. The detailed rules relating to the option to tax changed in June 2008, and are set out in VAT Notice 742A

The rate of VAT increased to 20% effective 4 January 2011. The ability to recover input VAT is of increased importance in view of the increase in the rate of VAT. In R (Argyll House Developments) v Revenue and Customs Commissioners [2009] STC 2698, the court held that on its true construction the concession allowing for recovery of input tax beyond the six month cut-off prior to the date of registration for VAT only applied to those who were required to register for VAT because of their election to waive the VAT exemption. The taxpayer’s VAT registration was not triggered by its election and it was, therefore, unable to recover the VAT on costs it had incurred before the six month cut off.

Opting to Tax

If a landowner opts to tax then he must do so in relation to the building, not merely a particular part, the particular tenancy or a specific rent. In a multi-tenanted commercial block the landlord must effectively choose to charge VAT to all his tenants or none of them.

Physically connected properties (eg units in a shopping centre 'grouped around a fully enclosed concourse') are considered one building. By contrast, discrete units on a retail or business park or industrial estate may be treated separately for the purposes of the option to tax.

If a landowner opts to tax a mixed use building, the option will not apply to those parts intended to be used for residential or charitable purposes.

Since 1 June 2008, it has also been possible for landowners to opt to tax in relation to their whole portfolio of UK property. This new procedure (the Real Estate Election, or ‘REE’) is explained in VAT notice 742A.

Once an option to tax has been made it can be revoked within a 'cooling off period' of six months after the effective date of the option, but only if:

• less than six months have passed since the day on which the option had effect

• no tax has become chargeable as a result of the option on any supply in relation to the property

• no transfer of a going concern has occurred, and

• the landowner has notified HMRC

VAT notice 742A specifies that one of three conditions must be met, where prior permission is not obtained for the revocation within the six month 'cooling off period':

• neither the person who exercised the option (nor a relevant associate) has recovered input tax attributable to supplies which would be taxable by virtue of the option

• by virtue of the revocation the person who exercised the option (and all relevant associates) would be liable to account for all such input tax they have recovered under regulations relating to the adjustment of partial exemption attribution at the end of a ‘longer period’ and to clawback

• such input tax has been recovered entirely on one capital item (as specified in the regulations) and amounts to less than 20% of the total input tax incurred on that item

However, if, at the time of making an option, the person opting intends to revoke it during the six month cooling off period, the option is treated as invalid.

Revocation without prior consent is effective only if none of the input tax of the person who made the option (or a relevant associate of that person) is 'allowable for credit' - VAT Notice 742A

The option to tax can be revoked after 20 years as long as the conditions set out in VAT notice 742A are satisfied.

Any option to tax will now automatically fall away if the person who opted has not had a relevant interest in the land for six years, unless:

• the person who opted has sold the property such that an additional payment (eg overage) may be payable after the time when the option would otherwise be revoked (‘the relevant time’)

• the person who opted has been a member of a VAT group during any time in the relevant six year period, and

• any relevant associate of that person has left the VAT group before the relevant time and any of the following applied:

• • the relevant associate had an interest in the property

  • prior to leaving the group the relevant associate sold the property such that an additional payment may be payable, or

  • the relevant associate was connected to the person who opted or another relevant associate of him and that person had an interest in the property

or

• at the relevant time, a relevant associate of the person who has opted is a member of the same VAT group and either currently holds an interest in the property or has held one during the previous six years

The effect of the Option to Tax

Opting to tax imposes the obligation to charge VAT not only on rents but also on the eventual disposal of the landowner's interest unless it qualifies as the transfer of a going concern or ‘TOGC’. The detailed criteria for TOGCs are set out in VAT Notice 700/9.

Some tenants (banks, building societies, insurance companies, medical or dental practices) are wholly or partially exempt businesses and so cannot recover all their VAT inputs. The effect of the landowner exercising the option to tax will be to increase the rent bill by up to 20% in real terms, with potentially adverse effects at rent review.

In these circumstances VAT exempt tenants might persuade the landowner to covenant not to opt to tax in exchange for the tenant paying a premium or an uplift in the rent. The tenant will want to be sure that the landowner and any successor as landlord is committed not to exercise the option to tax during the tenancy. To protect against an option to tax by a company in the same VAT group as the landowner, the covenant could either specifically mention those other companies or state that 'no option to tax shall be exercised'. Neither course would directly bind other members of the landowner's VAT group, but they would provide the tenant with recourse against the landowner should an option to tax be made in breach of that covenant.

Charities are permitted to exclude the option to tax where:

• a building or part of a building (other than used as an office) will be used by a charity solely for a relevant charitable purpose

• a grant is made in a building or part of a building designed solely for a relevant residential purpose

• a grant in a building or part of a building is made to a person who intends to use the building solely for a relevant residential purpose

HMRC accepts that, where the parties agree, the relevant residential or charitable use can incorporate a de minimis margin. The requirement is satisfied where it is 95% or more.

VAT and SDLT

Where VAT is chargeable on the rent under the lease at the effective date of the lease, VAT is included in the rent for the purposes of calculating the SDLT payable on the rent. However, if the landlord has not elected to waive the exemption from VAT before the effective date of the lease, VAT is ignored for the SDLT calculation.

VAT returns and insolvency

A duly signed VAT return gives rise to a debt sufficient to ground a statutory demand, bankruptcy petition and order. The insolvency courts can only look behind tax liability established by the statutory procedures in the tax regime in exceptional circumstances (Chamberlin v Revenue and Customs Commissioners [2011] All ER (D) 250 (Mar)).