Commercial Property, as an asset class, makes an attractive investment option for many people. An investor buys a commercial property – for example a shop, factory, warehouse, hotel – and then rents the building to a tenant who occupies the premises for the purpose of running their business.
Larger businesses can have subsidiary companies that buy property investments to rent back to their own trading operations, and business owners can use their pension funds to acquire property investments that support their trading companies’ growth.
Commercial property investments are generally high value transactions; it is not unusual for the VAT associated with a property acquisition to be tens, even hundreds of thousands of pounds. Consequently, managing any VAT issues can be critical to the viability of an investment.
When considering any potential investment there are two main VAT points that should be considered: -
As with most things VAT related, the answer is “it depends”.
Commercial property is exempt from VAT as a default. This means that, as a general rule, owners cannot charge VAT when selling their property, and landlords cannot charge VAT when renting it. However, the flipside of this is that property investors cannot reclaim the VAT on any of the costs they incur in managing their investment, or if they do works to refurbish or extend the buildings they own.
If they wish to change this, a landowner can make a tax election called the Option to Tax. Essentially, the landowner promises to charge VAT on all rental income, and/or the sale of the property itself, for at least twenty years. In return, they are then able to reclaim any VAT they pay on costs related to the property.
This aspect is relatively straightforward: if the vendor can evidence that they have notified HMRC of an Option to Tax on the property they’re selling, then they are likely obliged to charge VAT.
If the vendor has not notified Option to Tax to HMRC then they cannot legally charge VAT when selling. Identifying this early in a transaction means that VAT on the transaction can be managed by ensuring that your solicitor includes appropriate warranties in the sale contract to ensure that VAT does not become a ‘surprise’ after the purchase has completed.
Where a seller has notified Option to Tax to HMRC, the main way of avoiding VAT on selling the property will be to structure the sale as a Transfer of Going Concern (TOGC).
TOGC will be relevant if the seller has been renting the property out to a tenant before the sale, and you intend to retain that same tenant in place once the property is transferred to your ownership.
To qualify as a TOGC, both seller and buyer need to be VAT Registered and have notified Option to Tax on the property to HMRC before the transfer of the property is completed. There also has to be a tenant in place; ideally there will be a formal lease or licence between the building’s seller and occupational tenant, but this is not strictly necessary and an experienced tax adviser will be able to determine if additional legal work is needed before the sale to prevent any VAT issues.
If the building is vacant, or if you as buyer have sourced a tenant for a vacant property and arranged for the building’s seller to agree a lease with them before you buy the building, it is unlikely that TOGC conditions will have been met and it would be wise to take specific advice.
If the transaction is not VAT Exempt and TOGC conditions are not met – for example the building is vacant, perhaps because a current tenant will be required to leave before you buy – it is likely you will have to pay VAT to the seller. In the first instance, this represents a cash flow issue as the VAT will have to be financed until it can be reclaimed from HMRC.
In order to recover this VAT from HMRC you will need to satisfy two main conditions: evidence of the VAT paid, and intention to use the building in the course of a business that charges VAT to its customers.
The basics of VAT still apply to a property transaction, on the same basis as any other.
VAT can only be reclaimed from HMRC if you hold sufficient appropriate evidence to support the reclaim. If you buy a whole building, it is likely that your subsequent VAT Return will show a large repayment due back from HMRC – and it is wisest to assume they will carry out a ‘credibility check’ on the return before they authorise any payment. Therefore, it normally pays to have the necessary paperwork on hand to ensure that everything can be processed quickly.
With a property, it is also wise to have evidence of the vendor/landlord’s Option to Tax on the property in question. This evidences their obligation to charge VAT and having it on hand is valuable insurance against HMRC trying to disallow the VAT claim and forcing you back to the vendor/landlord to seek damages from them – normally a costly and time-consuming legal process that should be avoided if at all possible.
It is usually well worth having your tax adviser review this paperwork before the transaction completes, so you have assurance that there are ‘no surprises’ lurking.
The other basic VAT rule that applies here is the nature of your business. If you do not notify HMRC that you have made an Option to Tax on the building being acquired, then you will not be able to charge VAT to any tenant in the building. As a result, your income would be VAT Exempt and a claim to recover VAT paid on the purchase would be disallowed by HMRC.
In order to secure a VAT repayment, you would need to notify HMRC that you had made an Option to Tax on the property. Ideally notification should be made before the first rent is due from a tenant or before submitting the VAT Return (due after purchase of the property).
If you are using either your pension fund or a property investment company to acquire premises for occupation by another business you own or control, there is one further consideration you should review.
Where a related business is intended to occupy a building, it is not sufficient for the property owner to have notified Option to Tax. It is also necessary that the tenant going into the building is one that will charge VAT on at least 80% of their income. If the related party does not meet this requirement, then the Option to Tax may be ‘disapplied’ by HMRC and VAT on purchase of the property may be blocked.
If you suspect this may apply to you, then bespoke advice would be wise as the rules governing connected tenants are some of the most complicated in the VAT arena.
The circumstances of the property’s initial purchase may dictate that you need to notify Option to Tax to HMRC in order to either meet TOGC conditions, or reclaim VAT charged to you on the purchase. In this case, you are obliged to add VAT to any rent due by the tenant and pay this across to HMRC via ongoing periodic VAT returns.
If you were not ‘forced’ to notify Option to Tax during purchase of the property you may still wish to do so. The decision here will depend on your plans for the property. If it is vacant and there are substantial works required to make the building tenantable then it may be appropriate to notify Option to Tax so the VAT on renovation costs can be recovered.
Making this decision is a case of weighing up the immediate benefit of a VAT reclaim against the ongoing administration of a VAT Registration and the potential that VAT on rent may make the property less desirable to some tenants (those who cannot recover all the VAT they pay) thus impairing the commercial viability of the investment. An experienced advisor can help talk through the issues and determine which course of action is best for you.
It is worth noting that if you have notified Option to Tax then it covers all supplies related to the property. This means that if, as landlord, you are obliged to insure the building and then recharge that cost to the tenant, then the recharge should have VAT applied to it.
Even though insurance itself is exempt from VAT, that VAT exemption only applies to the contract between the insurance company and the insured person (in this case you as landlord). The VAT exemption does not apply to the subsequent recharge from you to the tenant. The recharge is regarded as part of the overall supply of the property and therefore VAT liability is the same as rent: exempt, unless the landlord has notified Option to Tax.
This rule operates ‘in reverse’ also. For example, if a landlord maintains telephone lines for alarm systems, or maintains the landscaping around a building these would normally be subject to VAT. If the landlord has not notified Option to Tax, they cannot charge VAT to their tenant and therefore must recharge the VAT inclusive values to the tenant.
As always, if this is unclear an experienced advisor can help explain how the rules apply to your situation and help ensure you are compliant.
Most investors who have to pay VAT on the cost of properties acquired for rental income should be able to recover the VAT on their next VAT Return, provided they notify HMRC that they have an Option to Tax on the property concerned. When buying a property, VAT will be a significant cash flow bump, but not an absolute cost. Depending on the nature of the deal, they may also be able to structure the transaction as a TOGC so that VAT is avoided on the initial acquisition.
If an investor has notified Option to Tax in respect of a property, then they are obliged to charge VAT when they ‘supply’ the property – this includes not just main rent but also any service charges or insurance recharges that are due by the tenant to the landlord.
Even if VAT was not a key issue in the initial acquisition of a property, there are circumstances where an investor may choose to notify Option to Tax to HMRC so they can protect their own costs when doing substantial works to the property.
Anyone undertaking investment in commercial property should ideally take advice to make sure VAT does not cause any surprises.
If you have any questions or need VAT advice on investing in commercial property as an investor, speak to an experienced advisor or our Associate Director, Iain Harris, who can point you in the right direction. Call him on 0131 364 4191 or email Enable JavaScript to view protected content..
Please note the above commentary is a general guide only, and should not form the basis of specific decision-making.
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