The UK property law and value added tax (VAT) rules do not make a good match and their interaction frequently leads to problems. Most businesses own or rent business premises and other property, so they frequently come into contact with aspects of property law and value added tax. The VAT law is therefore a potential problem area for businesses, and they may pay needlessly large sums of VAT in connection with their property transactions. Much of this value added tax could be avoided with careful and timely planning.
Many of the problems arising from value added tax and property result from the differing VAT treatment of different types of transaction. Although some property transactions can be zero-rated, others are charged at the standard rate or a reduced rate of VAT. Some transactions are exempt, and businesses can easily find that the VAT (input tax) paid on transactions relating to these exempt supplies cannot be recovered. A business can find itself in a partial exemption situation where a proportion of VAT paid on business overheads is lost. It is therefore important for businesses to consider these possibilities before transactions take place.
VAT on residential property
The construction and the sale (or lease over 21 years) of “dwellings” (residential property) is zero rated for VAT purposes. This means that no VAT is added to the sale price or the rent, and that the person selling or renting the residential property can reclaim the VAT paid on transactions connected with the sale. As the construction of a dwelling, as well as the sale, is zero rated, the business constructing the building will also not charge VAT on its services and will reclaim VAT paid on the expenses of construction.
Where a non-residential building (for example a barn) is converted into a residential dwelling, this is also zero rated. The zero rating is also available for alterations to listed buildings and to some other types of building.
Where residential property is let on a short lease (less than 21 years) the transaction is exempt from VAT, so rent will be paid without the addition of VAT but the person renting out the residential property will not be able to reclaim VAT paid on expenses in connection with the supply of the property.
This can give rise to problems where a house builder has built residential properties with the intention of selling or letting them on a long lease, but owing to a downturn in the property market it is not possible to sell the property. The only way of gaining a return on the investment in the short term may then be to make the property available for short-term lettings, which are VAT exempt. There is no option to waive the VAT exemption on residential property.
The result can be that some VAT incurred on the construction of the property cannot be reclaimed, with the result that VAT already reclaimed on past returns may need to be adjusted. To see if they will fall into partial exemption provisions and need to disallow VAT paid on overhead expenses, businesses may need to perform a computation to compare the total VAT paid (input tax) relating to the exempt supply with the expected period of exempt letting. If the average input tax incurred per year falls into the “de minimis” provisions, no adjustment is required on VAT paid in respect of overheads.
VAT on commercial property
The sale of new commercial property is charged to VAT at the standard rate if the property is less than three years old (in other words less than three years have elapsed since completion). Sales of commercial property after this three-year period will be exempt from VAT. The rent of any commercial property is also exempt from VAT.
Although an exempt supply of property means that VAT paid on expenses connected to that supply cannot be recovered, it is possible for businesses to opt to waive the exemption. This option, also called the “option to tax”, means that businesses can choose to add standard rate VAT to the price of the transaction and retain the right to deduct VAT on expenses related to the supply. The business will need to consider the consequences for the buyer of increasing the price. If the buyer is registered for VAT and able to fully reclaim VAT paid on the transaction, there may not be any problem in persuading them to accept the higher price.
Reduced VAT rate
The reduced 5% VAT rate applies to conversion work that leads to a change in the number of dwellings in a building, or creating a residence from a non-residential building. The reduced rate also applies where a dwelling that is currently designed for a single household has been empty for at least two years and is renovated or altered.
VAT on alteration of listed buildings
Work on a protected building, which includes a Grade I or II listed building or an ancient monument, is zero rated subject to certain conditions. The work must qualify as an approved alteration (rather than repairs or maintenance) that needs listed building consent, which must be applied for and received before the work begins.
There is a special VAT provision for “do it yourself” (DIY) builders who build their own homes, to ensure that they are on a level playing field with regard to claiming a refund of VAT on their purchases of materials. Under the DIY builders scheme a private person can reclaim VAT on the building materials used in building a dwelling. The person must be constructing a dwelling for residential use or be converting another building into a residence. The scheme only applies where a new dwelling is being created, and does not apply to renovating an existing house or improving a house that has already been bought.
HM Revenue and Customs www.hmrc.gov.uk
“Value Added Tax” by Andrew Needham and Steve Allen, Bloomsbury Professional, 2009