That’s VAT!

Tuesday 16 December 2014

The VAT element of a commercial property transaction is important for all parties involved (buyers, sellers, landlords, tenants and of course their respective solicitors) and it is critical for VAT to be addressed at the outset of every transaction and, crucially, to be specifically addressed in the contract itself.

A commercial property developer/landlord is able to charge VAT when selling or leasing their property either because it is a standard rated supply already or because they have opted to tax (OTT).

Standard rated supplies include: the sale of a freehold building completed less than three years before sale and the sale of a building not yet completed (whether or not preceded by a letting).
Exempt supplies include: the freehold sale of a building (at least three years old) where the option has not been exercised, any sale of a leasehold interest in land, buildings or civil engineering works where the option has not been exercised, the grant of a lease for a premium or at a rent where the option has not been exercised.

The Option To Tax

This was introduced on 1 August 1989 to mitigate against the effects of previous tax legislation from which landlords/developers were left out of pocket after they incurred irrecoverable input tax on freehold purchases or construction costs. It is the mechanism by which commercial property owners are allowed to change what would otherwise be an exempt supply into a supply chargeable at the standard rate. This enables the owner to recover the VAT costs with which they were faced when they acquired or developed the property.

Procedure

• Owner should check they are VAT registered or register for VAT.
• Written notice of the option must be given to HMRC within 30 days.
• The owner/seller should keep records before completion

To Opt or Not to Opt?

If no input tax has been incurred, there would be no reason for the option to be made.

Consideration should be given to the effect of the OTT on the tenant or purchaser who might not be able to similarly recover the tax through the course of their business. The additional costs might be extremely off-putting to such parties and therefore affect the marketability of the property.

Issues for a seller to consider

Upon the sale of a new commercial building or an old commercial building where the OTT is made prior to exchange of contracts, the general rule is that the purchase price stated in the contract is deemed to include VAT, unless the contrary is evident. Therefore, it is crucial that the seller includes a clause in the contract requiring the buyer to pay VAT in addition to the purchase price. If the seller fails to do this, then the seller themselves will be responsible for the VAT out of the purchase price received.

Issues for a buyer to consider

The situation is different if the OTT is made after exchange of contracts as a seller could add VAT to the purchase price without the need for an express clause. In this scenario, it is the buyer’s solicitor’s responsibility to ensure that there is an express provision in the contract (or the seller has given a warranty) that they have not OTT and will not OTT before completion.

Issues for a tenant to consider

A landlord may OTT in the grant of a commercial lease and in respect of existing leases and they do not need the benefit of an express clause in the lease to do so. The landlord could simply start adding VAT to the rent and any other sums payable under the lease. The only way round this is to insist on an express clause in the lease exonerating the tenant from VAT liability or prohibiting the landlord from exercising the OTT.

Issues for a landlord to consider

If an OTT is made prior to the grant of a lease then the rent will be deemed to be inclusive of VAT. It is therefore critical that the landlord’s solicitor ensures there is a covenant in the lease for the tenant to pay VAT on the rent (and any other sums). Ideally, this covenant should be included whether or not the landlord is currently or planning to take advantage of the OTT as it avoids any future issues.