Taxation in property - Value Added Tax (VAT)

Learning Outcomes

This article covers Value Added Tax (VAT) in property transactions in England and Wales, including:

• Determining when VAT applies to sales, leases and licences of land, and distinguishing residential and commercial treatment
• Differentiating standard-rated, zero-rated and exempt supplies and the implications for input VAT recovery
• Understanding and advising on the option to tax: purpose, effect, notification, duration and revocation
• Applying the “new building” rules for residential and commercial property
• Identifying when a sale of a let property can be treated as a TOGC and the conditions to secure it
• Drafting contract and lease provisions to manage VAT (exclusive vs inclusive pricing, gross‑up, service charge and tax points) and avoid price erosion
• Managing the interaction between VAT and SDLT/LTT, including the VAT‑inclusive base for calculation
• Conducting VAT‑focused due diligence: VAT registration, option‑to‑tax status, HMRC acknowledgments and prior uses
• Recognising VAT‑sensitive clients and the practical impact on recovery, cashflow and deal structure
• Spotting common VAT traps in SQE2 scenarios (e.g. holiday accommodation, car parking, opted properties, silent contracts)

SQE2 Syllabus

For SQE2, you are required to understand VAT in the context of property law and practice, with a focus on the following syllabus points:

• 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
• VAT recovery: registration, input tax, and VAT‑sensitive clients (partial exemption in outline)
• Transfers of a Going Concern (TOGC): conditions and common pitfalls
• SDLT/LTT charged on the VAT‑inclusive consideration where VAT applies
• Tax points, VAT invoices, and practical timing issues
• Due diligence: verifying VAT registration, the option to tax, prior uses, and evidence on file

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 also affects related taxes: if VAT is chargeable on a purchase, SDLT in England or LTT in Wales will be assessed on the VAT‑inclusive price, increasing the overall cost of acquisition.

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. That distinction is critical: zero‑rated supplies are still taxable supplies, allowing recovery of related input VAT, whereas exempt supplies are outside the VAT charge and usually block recovery of related input VAT.

Key Term: zero-rated supply
A taxable supply charged at 0%. No VAT is added to the price, but the supplier may recover related input VAT.

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.

Key Term: tax point
The time of supply determining the VAT period in which output tax is due. For services like leasing, it is generally when the service is performed or when an invoice is issued/consideration is received if earlier.

VAT on Property: The Basics

Value Added Tax is a tax on the supply of goods and services made in the UK by a taxable person in the course of business. In property, supplies include sales (e.g. freehold transfers, assignments of leases by tenants) and lettings (e.g. grants of leases and licences to occupy).

In broad terms:

• Residential property transactions are usually exempt, with important zero‑rate exceptions for new dwellings constructed by developers and certain first grants of major interests.
• Commercial property transactions are generally exempt unless the property is “new” (which brings the sale within the standard rate) or the owner has opted to tax.

When VAT applies to a purchase, SDLT/LTT is calculated on the VAT‑inclusive price. Conversely, where a transaction is zero‑rated (e.g. the first sale of a newly built dwelling by the developer), no VAT is charged and input tax on related costs is normally recoverable by the developer.

Key Term: exempt supply
A supply where VAT is not charged and input VAT related to that supply is generally not recoverable.

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. Zero rating also typically applies to the first grant of a “major interest” (freehold or a long lease) in a newly constructed dwelling by the person who constructed it. This enables recovery of VAT on construction and professional costs.
• Short‑term holiday letting of residential property, hotel-type accommodation, and similar facilities are standard‑rated. A lease or licence to occupy for holiday accommodation will usually attract VAT at 20%.
• Buy‑to‑let sales and secondary market sales of dwellings are usually exempt. The vendor is commonly a private individual selling outside the course of business or, if in business, making an exempt supply.
• Land sold for residential development may be exempt unless the seller has opted to tax, in which case VAT at 20% may be chargeable on the land price; a residential developer can usually recover that VAT as input tax because its onward supplies (first sales of the new dwellings) are zero‑rated.

Practical points:

• The exemption for residential lettings means landlords generally cannot recover VAT on maintenance and repair costs for exempt residential lettings. However, costs tied to the construction of new dwellings which will be zero‑rated on first sale can often be recovered.
• Student accommodation, care homes and similar “relevant residential” uses have their own regime on construction and first grant which may be zero‑rated, but subsequent sales are typically exempt.

Commercial Property

General rule:

• The sale or lease of commercial property is exempt unless:
  • The freehold is “new” (completed within the last 3 years) – in which case its sale is standard‑rated at 20%; or
  • The seller or landlord has exercised an option to tax, converting otherwise exempt supplies of that commercial land/building into taxable supplies at the standard rate.

Points to note:

• The grant of a lease of commercial property is ordinarily exempt irrespective of the building’s age, unless the landlord has opted to tax. Once opted, VAT is added to rent, premiums and most service charges associated with the opted property.
• An assignment by a tenant of its lease is, in principle, an exempt supply of an interest in land by the tenant (unless the tenant itself has opted to tax for that property). The landlord’s option to tax does not automatically make a tenant’s assignment standard‑rated; options to tax are personal and property‑specific.
• Certain supplies connected with commercial occupation (e.g. car parking, storage) can be standard‑rated irrespective of an option to tax, but the core sale/lease treatment follows the rules above.

Key Term: new commercial building
A non‑residential building completed within 3 years of the supply. A freehold sale within 3 years is standard‑rated at 20%.

Exercising the Option to Tax

By default, sales and lettings of commercial property (other than new freehold sales) are exempt. An owner can elect to charge VAT on the supply to recover VAT on related costs (e.g. acquisition VAT on an opted building, professional fees, refurbishment).

• Once exercised, the owner must charge VAT at 20% on the sale price or rent and on most service charges for that property.
• The option is personal to the owner and property‑specific; it does not automatically transfer to a purchaser on a sale. A buyer who wants taxable supplies in future may need to exercise its own option to tax post‑acquisition.
• HMRC must be notified of the option. As a general rule, notification is required within 30 days of the decision to opt. The option typically lasts for at least 20 years.
• There is a limited ability to revoke within six months if the option has not been put into effect (e.g. no VAT has yet been charged) and, after 20 years, revocation may be possible with HMRC’s consent.
• The option to tax does not apply to residential land and buildings (it cannot be used to convert a dwelling sale/letting into a standard‑rated supply).

Key Term: VAT-sensitive client
A business (e.g. many banks, building societies, insurers, and charities) that cannot fully recover VAT; VAT charged to them is an irrecoverable cost.

Commercial considerations:

• Opting to tax can make a property less attractive to VAT‑sensitive buyers or tenants, who may discount rent or price for the irrecoverable VAT cost.
• Conversely, opting may be essential to recover substantial input tax on development or refurbishment. It is often a balance between recoverability for the owner and marketability to the target occupier class.

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.

• Standard conditions of sale provide that the price is inclusive of VAT unless the contract states otherwise. Under the Standard Conditions (SC 1.4.1), a special condition is required to allow the seller to charge VAT in addition to the price where VAT is, or may become, chargeable.
• For transactions subject to VAT (by default or via option to tax), contracts should state whether the price is VAT‑exclusive (VAT added on top) or VAT‑inclusive (the price includes any VAT chargeable).
• Leases should address VAT on rent, deposits, premiums, service charge and insurance rent, and contain a VAT gross‑up so the landlord receives the intended net sum after VAT.
• Always consider the tax point (time of supply). Invoices and deposits received before completion can trigger earlier accounting for VAT, which may affect cashflow and timing.
• Replies to Commercial Property Standard Enquiries (CPSEs) should be scrutinised for VAT registration, option‑to‑tax notifications/acknowledgments, and past uses that might affect VAT treatment. Seek documentary evidence (e.g. HMRC acknowledgment of the option).

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.

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%.

Worked Example 1.4

A seller has opted to tax a let office building and sells the freehold to a buyer who will continue the letting business. Both parties are VAT registered. Can the sale be treated as a TOGC so no VAT is charged?

Answer:
Potentially yes. Sale of a rented property can be a Transfer of a Going Concern (outside the scope of VAT) if: the seller and buyer are VAT registered; the property is sold subject to existing lettings; the buyer intends to carry on the same letting business; and crucially the buyer has opted to tax the property and notified HMRC before the tax point. If any condition is not met (e.g. buyer fails to opt to tax in time), VAT is chargeable on the sale.

Worked Example 1.5

A buyer agrees to pay £1,000,000 for an opted commercial building. VAT at 20% is chargeable. On what amount is SDLT/LTT calculated?

Answer:
SDLT (England) or LTT (Wales) is calculated on the VAT‑inclusive consideration. Here, tax is computed on £1,200,000, not £1,000,000.

Worked Example 1.6

A landlord opted to tax a vacant unit but, within four months, decides not to proceed with the letting and has not charged VAT on any rent or premium. Can the landlord revoke the option?

Answer:
HMRC permits revocation within six months if the option has not been put into effect (e.g. no VAT has been charged on any supply). If these conditions are met and HMRC accepts revocation, future supplies revert to the default exempt position.

VAT Recovery and VAT-Sensitive Clients

Only businesses making VATable supplies (standard‑rated or zero‑rated) can usually recover VAT paid on purchases or related costs (input tax). Input tax is offset against output tax in quarterly returns; any excess can be reclaimed.

• A business making only exempt supplies cannot register for VAT and cannot recover input tax. Banks, building societies, insurers and many charities are typical VAT‑sensitive clients; VAT they are charged on property purchases or rents is often irrecoverable and becomes a real cost.
• Businesses making a mix of taxable and exempt supplies may face partial exemption rules limiting recovery. Although detailed calculations are beyond scope here, the practical effect is that full recovery may not be available unless the property is used wholly for taxable activities.
• VAT registration is compulsory when taxable turnover exceeds the registration threshold (historically £85,000; figures can change). Voluntary registration can facilitate input recovery even if turnover is below the threshold, provided the business makes taxable supplies.

Risks and Traps

• Failure to opt to tax can block recovery of input VAT on acquisition or refurbishment costs where the onward supply is exempt. This may undermine a business case for development.
• Contract silence: Under standard conditions, prices are inclusive of VAT unless expressly stated otherwise. If VAT is chargeable but the contract is silent, the seller may have to account for VAT out of the agreed price, eroding proceeds.
• SDLT/LTT uplift: Where VAT is charged on a property purchase, SDLT or LTT is calculated on the VAT‑inclusive price, increasing tax costs. This “tax on a tax” can be material on high‑value deals.
• TOGC pitfalls: If TOGC treatment is assumed but the buyer fails to opt to tax and notify HMRC before the tax point (or does not intend to continue the letting business), the sale is not a TOGC and VAT will be due, potentially with interest and penalties for incorrect treatment.
• Tax point issues: Deposits or invoicing before completion can trigger the tax point early. Manage invoicing and deposit arrangements to align with cashflow and HMRC rules.
• Lease drafting: Omit a VAT gross‑up and the landlord may bear irrecoverable VAT on service charge items. State clearly whether sums are exclusive and that VAT is payable in addition.
• Evidence and due diligence: Always verify VAT registration status, option‑to‑tax notification (and HMRC acknowledgment), and prior property use. Historic uses (e.g. partial residential) may complicate VAT treatment.
• Residential traps: Do not assume residential transactions are always outside VAT. Holiday lets are standard‑rated; the first grant of a new dwelling by the builder is zero‑rated; later sales are usually exempt.

VAT and Residential Developments

For developers of new homes, sales are zero‑rated. This allows recovery of VAT incurred on construction and professional services, encouraging development.

• Land acquisition: Bare land sales are typically exempt unless the seller has opted to tax. If VAT is charged on land, a residential developer making zero‑rated first sales can usually recover that VAT as input tax.
• Construction: Works to construct new dwellings are usually zero‑rated when supplied to the developer constructing the dwellings. Professional fees (e.g. architects, surveyors, lawyers) are generally standard‑rated, but the developer can recover VAT as input tax because its onward supplies are zero‑rated.
• First grant: The first sale (freehold) or first grant of a major interest (long lease) by the person who constructed the dwelling is zero‑rated if the building is designed as a dwelling and conditions are met. Subsequent sales are usually exempt.
• Buy‑to‑let: Sales of residential investment properties by landlords are typically exempt and VAT on associated costs (e.g. estate agents’ fees) is generally irrecoverable.
• Holiday accommodation: Lettings of holiday accommodation are standard‑rated, so landlords can recover input VAT attributable to those taxable supplies.

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.

Additional Practical Points for Leases and Sales

Leases:

• Rent, service charge and insurance rent in an opted building will ordinarily attract VAT at 20%. Include a VAT clause to gross‑up all such sums if VAT becomes chargeable.
• Repair and reinstatement contributions following insured damage, if expressed as additional rent or service charges, will generally follow the VAT treatment of rent when the landlord has opted to tax.

Sales:

• If a property is sold subject to existing tenancies and the parties intend TOGC treatment, ensure the buyer is VAT‑registered, has opted to tax and notified HMRC before completion, and will continue the letting business immediately after completion.
• If the contract contemplates a sale that could be either a TOGC or a standard‑rated supply (e.g. depending on buyer’s VAT position), add flexible VAT clauses to accommodate either outcome and oblige parties to cooperate to achieve the intended VAT treatment.

Key Term: Transfer of a Going Concern (TOGC)
A sale of a business (e.g. a letting business) as a going concern outside the scope of VAT. For property lettings, TOGC usually requires both parties to be VAT registered, the buyer to opt to tax and notify HMRC prior to the tax point, and continuity of the letting business.

Cross‑Tax Interaction: SDLT/LTT, VAT and Cashflow

• SDLT/LTT is payable on the VAT‑inclusive consideration where VAT is charged, increasing transaction costs. In Wales, LTT applies instead of SDLT.
• Cashflow planning matters where significant VAT will be charged: check whether the buyer can recover input tax rapidly, whether a VAT grouping is available, and whether TOGC treatment can be achieved legitimately to keep the transaction outside the VAT net.
• In financings, lenders often require comfort that VAT liabilities are identified and funded, and that SDLT/LTT calculations have included VAT where appropriate.

Due Diligence Checklist (VAT Focus)

• Is the seller/landlord VAT‑registered? Obtain VAT registration number and status.
• Has an option to tax been exercised? Obtain evidence of the decision, HMRC notification and (where available) HMRC acknowledgment.
• Is the property “new” for VAT purposes? Check completion dates of construction.
• What is the property’s use history (residential/commercial/holiday lets)? Any impact on current VAT treatment?
• Are there existing tenancies? If a TOGC is intended, will continuity conditions be met and has the buyer opted to tax?
• Do contract terms deal clearly with VAT (exclusive vs inclusive) and contain appropriate VAT cooperation and gross‑up provisions?
• In purchase cases, has the SDLT/LTT computation included VAT where chargeable?

Key Point Checklist

This article has covered the following key knowledge points:

• VAT is not charged on most residential sales, but sales (or first grants of major interests) of “new” residential dwellings by the person who constructed them are zero‑rated, enabling input VAT recovery on construction and related costs.
• Commercial property transactions are usually exempt, but VAT is charged if the freehold is “new” (less than 3 years old, standard‑rated) or the owner has exercised the option to tax (which converts supplies into standard‑rated).
• The option to tax is property‑ and owner‑specific, notified to HMRC (generally within 30 days), lasts for at least 20 years, may be revoked after 20 years (or within 6 months if unused), and does not apply to residential land/buildings.
• Contracts and leases must deal clearly with VAT. Under standard conditions, prices are inclusive of VAT unless a special condition permits VAT to be added. Include VAT gross‑up wording for rent and other lease sums.
• Where VAT is chargeable on a purchase, SDLT/LTT is computed on the VAT‑inclusive price.
• TOGC can keep a sale of a let property outside the scope of VAT if conditions are met (including buyer’s timely option to tax and intention to continue the letting business).
• Only VAT‑registered businesses making VATable supplies can recover input VAT. VAT‑sensitive clients (e.g. banks, insurers, charities) often cannot recover VAT, so VAT becomes a real, irrecoverable cost.
• Tax points and VAT invoicing affect timing and cashflow; deposits or early invoicing can trigger earlier liability.
• The risk to the seller if the contract is silent is that VAT is deemed included in the price. Accurate VAT advice and careful drafting protect clients from unexpected liabilities.

Key Terms and Concepts

• VATable supply
• zero-rated supply
• exempt supply
• option to tax
• new commercial building
• tax point
• VAT-sensitive client
• Transfer of a Going Concern (TOGC)