Taxation in property transactions - Value Added Tax considerations

Learning Outcomes

After studying this article, you will be able to identify the VAT treatment of residential and commercial property transactions, explain the difference between standard-rated, zero-rated, and exempt supplies, and apply the rules on the option to tax and VAT recovery. You will also be able to advise on practical VAT issues in property sales and leases, including the impact of VAT status on buyers and sellers, and answer SQE1-style MCQs on this subtopic.

SQE1 Syllabus

For SQE1, you are required to understand the VAT implications of property transactions, including the correct VAT treatment of residential and commercial sales and leases, and the practical impact of VAT on clients. In your revision, focus on:

• The VAT treatment of residential and commercial property transactions
• The meaning and effect of zero-rated, exempt, and standard-rated supplies
• The option to tax and its consequences
• VAT recovery and partial exemption rules
• The impact of VAT on sale and lease documentation
• Practical issues for buyers and sellers, including VAT registration and cash flow

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which of the following property transactions is usually zero-rated for VAT?
   1. Sale of a new residential dwelling
   2. Sale of an existing residential dwelling
   3. Lease of an existing commercial property (no option to tax)
   4. Sale of a new commercial property

2. What is the effect of a property owner exercising the option to tax on a commercial property?

3. True or false? A landlord who has opted to tax a commercial property can recover VAT on related expenses, but this may make the property less attractive to VAT-exempt tenants.

4. Which VAT rate applies to most construction services for new residential dwellings?

Introduction

VAT is a key consideration in property transactions and can have a significant financial impact for both buyers and sellers. For SQE1, you must be able to identify the correct VAT treatment for different types of property, explain the effect of the option to tax, and advise on VAT recovery and documentation issues. This article covers the essential VAT rules for residential and commercial property, including practical examples and common pitfalls.

VAT in Property Transactions: Core Principles

VAT is a tax on supplies of goods and services made in the UK by taxable persons in the course of business. The VAT treatment of property transactions depends on the type of property, the nature of the supply, and whether the supplier has opted to tax.

Key Term: VAT
Value Added Tax is a tax charged on the supply of goods and services in the UK by taxable persons in the course of business.

Key Term: Taxable person
A person or business registered (or required to register) for VAT, usually because their taxable turnover exceeds the VAT registration threshold (£85,000 per annum).

VAT Rates and Property

There are three main VAT rates relevant to property transactions:

• Standard rate (20%): Applies to most goods and services, including new commercial property and opted commercial property.
• Zero rate (0%): Applies to the first sale or long lease of new residential dwellings.
• Exempt: Applies to most sales and leases of existing residential property and most commercial property unless the option to tax has been exercised.

Key Term: Zero-rated supply
A taxable supply charged at 0% VAT. The supplier can recover input VAT on related costs.

Key Term: Exempt supply
A supply not subject to VAT. The supplier cannot recover input VAT on related costs.

Residential Property and VAT

New Residential Property

The sale or long lease (over 21 years) of a new residential dwelling is zero-rated. This allows developers to recover VAT on construction costs and professional fees.

Existing Residential Property

The sale or lease of an existing residential property is exempt from VAT. No VAT is charged to the buyer or tenant, but the seller or landlord cannot recover VAT on related expenses (e.g. repairs, improvements).

Construction Services

Most construction services for new residential dwellings are zero-rated. Some qualifying conversions and renovations may be eligible for the reduced rate (5%).

Commercial Property and VAT

New Commercial Property

The sale or lease of a new commercial property (less than three years old) is standard-rated (20%). VAT is charged on the sale price or rent.

Existing Commercial Property

The sale or lease of an existing commercial property is usually exempt from VAT. However, the owner may choose to charge VAT by exercising the option to tax.

Key Term: Option to tax
A formal election by a property owner to charge VAT on supplies of commercial property that would otherwise be exempt. Once made, it generally lasts for 20 years.

Effect of the Option to Tax

If the option to tax is exercised, the supply of the property becomes standard-rated (20%). This allows the owner to recover VAT on related expenses, but may make the property less attractive to tenants or buyers who cannot recover VAT (e.g. charities, banks).

VAT Recovery and Partial Exemption

A VAT-registered business making only taxable supplies (standard or zero-rated) can recover input VAT on related costs. If the business makes both taxable and exempt supplies (e.g. a landlord with both opted and non-opted properties), it must apportion input VAT using the partial exemption rules.

Key Term: Partial exemption
The method by which a business that makes both taxable and exempt supplies determines how much input VAT it can recover.

VAT Registration

A business must register for VAT if its taxable turnover exceeds the registration threshold (£85,000 per annum). Voluntary registration is possible below this threshold.

VAT and Documentation

The VAT status of the transaction must be reflected in the sale contract or lease. For commercial property, the contract should state whether the price is inclusive or exclusive of VAT, and whether the seller has opted to tax.

Worked Example 1.1

A developer sells a new residential flat for £300,000. What is the VAT treatment, and can the developer recover VAT on construction costs?

Answer:
The sale is zero-rated. The developer charges 0% VAT on the sale price and can recover input VAT on construction costs.

Worked Example 1.2

A landlord owns an existing office building and opts to tax. They lease the building to a VAT-registered business. What is the VAT treatment of the rent, and can the landlord recover VAT on repairs?

Answer:
The rent is standard-rated (20% VAT). The landlord can recover input VAT on repairs and related costs.

Worked Example 1.3

A charity leases an office in a building where the landlord has opted to tax. What is the impact for the charity?

Answer:
The landlord charges 20% VAT on the rent. As the charity is not VAT-registered and makes exempt supplies, it cannot recover the VAT, increasing its costs.

Exam Warning

For SQE1, always check whether the property is new or existing, residential or commercial, and whether the option to tax has been exercised. The VAT treatment depends on these factors. Do not assume all property transactions are exempt from VAT.

Revision Tip

If a contract is silent, the price is deemed to be inclusive of VAT. Always specify in the contract whether VAT is to be added to the price, especially for commercial property.

Summary

Key Point Checklist

This article has covered the following key knowledge points:

• VAT treatment depends on property type (residential/commercial) and whether the property is new or existing.
• The sale or long lease of a new residential dwelling is zero-rated; existing residential property is exempt.
• The sale or lease of new commercial property is standard-rated; existing commercial property is exempt unless the option to tax is exercised.
• The option to tax allows VAT recovery on related costs but may affect the marketability of the property.
• VAT-registered businesses making taxable supplies can recover input VAT; partial exemption rules apply if both taxable and exempt supplies are made.
• The VAT status must be reflected in the contract or lease; always specify whether VAT is to be added to the price.
• VAT registration is required if taxable turnover exceeds the threshold; voluntary registration is possible.

Key Terms and Concepts

• VAT
• Taxable person
• Zero-rated supply
• Exempt supply
• Option to tax
• Partial exemption