VAT on Commercial Property: What are the rules?

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VAT in relation to commercial property is a complicated area with plenty to consider. Many business owners know that when they sell their business the sale will be free from VAT, but sometimes they don’t understand why. At Alexander & Co, our property accountants have shared some of the key VAT aspects to be aware of when leasing or purchasing a commercial property.

VAT Exemption

The lease or sale of a commercial property is usually exempt from VAT. If so, the tenant or purchaser does not have to pay VAT. Although this is a positive overall, when a landlord or vendor makes an exempt supply of a property, they cannot recover the VAT on all related costs, which can be substantial.

Opt to tax and commercial property

Commercial property owners have the option to charge VAT at 20% (currently the standard rate). When a landlord or vendor opts to tax property, they need to usually charge VAT on all supplies which relate to the property, therefore charging all rentals or sales. Landlords can, however, recover VAT that has been charged in relation to the property.

In the right circumstances, opting to tax can provide a real advantage, for instance, where expensive refurbishments have been required.

However, for some businesses it is not appropriate (or often, realistic) to opt to tax – many businesses simply cannot afford to recover VAT incurred on the costs. These include mainly businesses in health services and charity work. This is why it’s important to consider the market sector of potential tenants or purchasers before you make a decision.

HMRC needs to be notified in writing if you opt to tax. This decision is usually irrevocable, hence, why making the correct long-term decision is essential.

Transfer of going concern

Transfer of going concern (TOGC) is another consideration. When an opted to tax property is sold with the benefits of an existing lease or sold with tenants in place, the vendor is usually required to charge VAT at 20%. However, if the prospective owner allows the continuation of letting the property to the tenants, then subject to certain conditions, the transfer is a TOGC, therefore no VAT is charged on the purchasing price. In these circumstances, it becomes an attractive option.

Sale of ‘new’ commercial property

Finally, the sale of ‘new’ commercial property will be liable to VAT at the 20% rate. If a property is less than three years old, it’s deemed ‘new’. A purchaser of a buy-to-let commercial property is much more likely to choose an opt to tax, enabling them to recoup the VAT charged on the acquisition. Unless it’s TOGC, once opted in they will be required to charge and account for VAT on future rents and sales of the property.

What are the pitfalls?

As the rules on VAT and commercial property are so complex, there are more than a few pitfalls that you could fall down. To ensure that you’re fully informed, we’ve shone a light on some of the more problematic areas of commercial property and VAT.

Mixed-use properties

Taking a commercial site and developing it for residential use is one thing, but an aim to develop a property for the combined use of commercial and residential creates further potential stumbling blocks regarding VAT.

When it comes to VAT, commercial property is treated differently than residential which then affects the VAT that can be recovered on any expenditure, as well as the amount charged on the eventual sale of the property. It should also be noted that the VAT status of commercial space will vary depending on whether it is sold freehold or, alternatively, as a long lease. There’s a lot to think about.

What if you’re building from scratch?

The cost of constructing a new commercial building is normally liable to the standard rate of VAT (except when the building is to be used by a non-profit business or charity). So, the opportunity to recoup the VAT incurred through building and construction costs will depend entirely on how the building is used.

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With HMRC penalties for non-compliance and increasing property values, VAT mistakes can be costly. Getting correct and reliable advice from the beginning is important and the property team at Alexander & Co. can help guide you through the process. Make sure you get in touch for further information before making any transaction.

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