Taxation in property - Value Added Tax (VAT)

Learning Outcomes

After reading this article, you will understand how Value Added Tax (VAT) affects property transactions in England and Wales. You will be able to identify whether VAT applies to a sale or lease of property, advise on the effect of an option to tax, and highlight key contract considerations. You will also be prepared to spot VAT traps relevant to both residential and commercial property within the scope of SQE2 assessments.

SQE2 Syllabus

For SQE2, you are required to understand VAT in the context of property law and practice. This article focuses your revision on:

• The situations in which VAT applies to property transactions (sales or lettings)
• The distinction between standard-rated, exempt, and zero-rated supplies
• The significance and effect of exercising the option to tax
• The VAT treatment of residential vs commercial property
• Key contractual provisions regarding VAT in property agreements

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. When is VAT automatically chargeable on the sale of a property in England and Wales?
2. What is the effect of a seller exercising the "option to tax" in relation to a commercial property?
3. Does a commercial lease always attract VAT? Explain your answer.
4. What is the risk if a contract fails to make appropriate provision for VAT on the sale of a commercial property?

Introduction

VAT can have significant financial consequences in property transactions. It is essential for both solicitors and their clients to be aware of when VAT is payable on property, how and when it can be recovered, and the practical impact of these rules. Failure to advise accurately or prepare contracts appropriately can expose clients to substantial and unexpected costs.

VAT on Property: The Basics

Value Added Tax is a tax on the supply of goods and services. In property, supplies may include the sale or lease of land or buildings.

Key Term: VATable supply
A transaction subject to VAT at the standard or zero rate (not exempt).

The standard rate of VAT is currently 20%. Some property transactions are VAT-exempt or zero-rated, meaning no VAT is charged.

Key Term: option to tax
An election made by a property owner (registered for VAT) to charge VAT on what would otherwise be an exempt supply of commercial land or buildings.

When is VAT Payable on Land and Property?

Residential Property

The sale or long lease of residential property (flats, houses) is usually exempt from VAT. There are key exceptions:

• The sale of a new residential dwelling by a developer (within 3 years of completion) is zero-rated (VAT at 0%), which allows the developer to recover VAT on construction costs.
• Short-term holiday letting of residential property is standard-rated.

Commercial Property

General rule:

• The sale or lease of commercial property is exempt from VAT unless:
  • The property is "new" (built or completed within the last 3 years) – in which case its sale is standard-rated.
  • The seller or landlord has exercised an option to tax.

Exercising the Option to Tax

By default, sales and lettings of commercial property (other than new property) are exempt. The owner can elect ("opt") to charge VAT on the supply. This can allow the owner to recover VAT incurred on property costs.

• Once exercised, the seller or landlord must charge VAT at 20% on the sale price or rent.
• The option is personal to the owner and property-specific.
• HMRC must be notified, and the option generally lasts for at least 20 years.

Key Term: exempt supply
A supply (such as most residential sales and some commercial transactions) where VAT is not charged and VAT incurred on related costs cannot be recovered.

Contractual Issues: VAT in Property Agreements

Mistakes in contract drafting can cause a seller to lose 20% of the purchase price where sales are exclusive of VAT, or require a buyer to pay unexpected VAT if the contract is silent or ambiguous.

Key Points for Contracts

• For transactions subject to VAT (by default or option to tax), the contract should state whether the price is stated exclusive or inclusive of VAT.
  • "Exclusive" means VAT is charged in addition to the price.
  • "Inclusive" means the price includes any VAT chargeable.
• If the seller has opted to tax, the buyer or tenant will normally be charged VAT on top of the agreed price or rent.
• Standard conditions of sale or lease should be reviewed and may need to be supplemented with property-specific VAT clauses.

Worked Example 1.1

A developer wishes to sell a new office building (completed 1 year ago, never occupied). Is VAT charged on the sale? What about if the sale is after 4 years?

Answer:
If sold within 3 years of completion, the sale is automatically standard-rated, so the buyer must pay VAT at 20%. If more than 3 years have passed since completion, the sale is exempt unless the seller has opted to tax, in which case VAT is chargeable.

Worked Example 1.2

A business sells a shop that is more than 15 years old. The seller exercised the option to tax. The contract is silent as to VAT. What is the seller's risk?

Answer:
Even though the seller must account to HMRC for VAT (since they have opted to tax), if the contract is silent or states "inclusive of VAT", the seller may have to pay the VAT out of the agreed price, losing 20% of the sale proceeds.

VAT Recovery and VAT-Sensitive Clients

Only businesses making VATable supplies (standard-rated or zero-rated) can usually recover VAT paid on the purchase or on related costs (like professional fees). If a recipient of a supply cannot recover VAT (for example, most banks or insurance companies), VAT will remain an irrecoverable cost, so "VAT sensitivity" is a key commercial concern.

Key Term: VAT-sensitive client
A business (e.g., many financial institutions) or charity that cannot fully recover VAT, making VAT charged on property an irrecoverable expense.

Risks and Traps

• If the seller fails to opt to tax, input VAT on costs (construction, refurbishment, acquisition) will not be recoverable unless the sale or letting is standard-rated for another reason.
• Historic or mixed-use properties may have complex VAT treatments.
• Transfer of a property as a "Transfer of a Going Concern" (TOGC) in certain business asset sales may be outside the VAT net (special rules apply).
• Pre-contract due diligence should always include checking: VAT registration, option to tax status, prior uses of the property, and contractual terms.

Worked Example 1.3

A business enters an agreement to lease a 10-year old warehouse. The landlord has not exercised the option to tax. Is VAT charged on the rent? What if the landlord opts to tax before completion?

Answer:
Assuming the property is not "new," and no option to tax is in place, the lease is VAT-exempt and no VAT is chargeable. If the landlord exercises the option to tax before completion, the rent will be subject to VAT at 20%.

VAT and Residential Developments

For developers of new homes, sales are zero-rated. This allows for VAT incurred on construction and professional services to be recovered, encouraging development. Buy-to-let sales and secondary market sales of dwellings are exempt and do not permit recovery.

Summary Table: When is VAT Charged on Property?

Exam Warning

Many students incorrectly assume that all sales of commercial property must be subject to VAT. Do not make this mistake in advice or drafting contracts. Always check the property's age, use, and the seller's VAT status and whether an option to tax has been exercised.

Revision Tip

Always review the relevant contract schedules and title entries to confirm VAT status, especially where an option to tax may have been exercised.

Key Point Checklist

This article has covered the following key knowledge points:

• VAT is not charged on most residential sales, but sales of "new" residential dwellings are zero-rated (allowing input VAT recovery).
• Commercial property transactions are usually exempt, but VAT is charged if the property is new (less than 3 years old) or the seller/landlord has exercised the option to tax.
• The sale contract or lease must deal clearly with VAT, specifying whether prices are inclusive or exclusive.
• The option to tax is property- and owner-specific and must be notified to HMRC.
• Only buyers who are VAT-registered and making VATable supplies can recover VAT; VAT-sensitive clients cannot.
• The risk to the seller if the contract is silent is that VAT is deemed included in the price.
• Accurate VAT advice and careful contract drafting are essential to protect clients from unexpected liabilities.

Key Terms and Concepts

• VATable supply
• option to tax
• exempt supply
• VAT-sensitive client