Do the UK’s VAT and property rules need to be simplified?

Under the current rules most supplies of commercial land are exempt from VAT, subject to the landowner or landlord being able to opt to tax. Some supplies are automatically standard rated, such as new commercial buildings or specified short term interests such as hotel accommodation; and car parking and some supplies in relation to residential property are zero rated.

The call for evidence document (17-page / 232KB PDF) is surprisingly short on detail and in the main leaves it to those responding to examine the effect of possible changes. It presupposes that fundamental changes to the legislation are required to achieve simplicity and certainty for taxpayers. However, many of the current problems with the system are caused not by the legislation per se, but by the difficulty of identifying whether supplies are or are not of an interest to land.

Greater certainty could be achieved if HMRC was more adequately resourced and had a publicly accessible register of options to tax or a more streamlined system for acknowledging them. A timely clearance system for difficult cases would also be beneficial to aid certainty.  

The call for evidence briefly discusses three substantial changes to the current rules which were considered and rejected by the Office for Tax Simplification in 2017 (85-page / 868KB PDF), as part of a wider review of the VAT system. These are:

• removing the ability to opt and making all land transactions exempt;

   

• removing the option to tax and making all land and property taxable but at a reduced rate; and

   

• making all commercial land and property taxable at the standard rate with an option to exempt.

None of these options are attractive.

Removing the ability to opt and making all land transactions exempt would simplify the regime but would take away choice from taxpayers and potentially lead to considerable amounts of irrecoverable VAT in respect of construction and property management costs for commercial and especially residential property.

Removing the option to tax and making all land and property taxable at a reduced rate would again simplify the system, but would increase the costs of residential property, even if this was taxed at a lower rate than commercial property. It would also increase property costs for exempt tenants such as financial services businesses.

Making all commercial land and property taxable at the standard rate with an option to exempt would be a substantial change to the system, with few obvious benefits. A register of options to exempt would also need to be established, and complexities which currently exist with the option to tax would surely be replicated in an option to exempt, with the disadvantage that the system will be unfamiliar to taxpayers and advisers.

Simplifying VAT on land by making short-term or minor interests subject to VAT is an area for possible change highlighted by the call for evidence which could have some merit, provided longer interests were exempt, and remained subject to the option to tax. This would simplify the legislation as it currently has to list many short-term interests such as car parking, hotel accommodation and the like so that they can be excluded from the exemption if they are supplies of land. What the cut-off date for ‘short term’ would be is perhaps problematic – a few days is not long enough but a year might be too long.

Another option mentioned in the call for evidence is to make most supplies of land and property subject to VAT but to exempt certain specified supplies of land and property, such as residential accommodation and charitable buildings. This would remove the option to tax, so would increase irrecoverable VAT for VAT exempt tenants and would make the regime much less flexible than it is currently, but does at least preserve the status quo for residential property.

A final option suggested in the call for evidence is to link the VAT liability of supplies of land and property interests to those that have been registered with the Land Registry. This suggestion has very little merit and fails to recognise that only legal interests are registered but that VAT applies also to beneficial interests. It would also presumably have to include an exclusion or a lower rate of VAT for residential property.

Some of the changes contemplated in the call for evidence could lead to increased VAT in relation to residential property. It is important that this is avoided. Having to charge VAT to tenants or incurring irrecoverable VAT for example, in relation to build to rent projects, could affect the viability of these projects as well as driving up costs for tenants.  It is disappointing that HMRC are not restating a commitment to the benefit of zero rating in the sector.

The VAT and property system is undeniably complex, but most taxpayers and their advisers who deal with it regularly are experienced in its application. In our view, wholesale reform is not the answer. Instead, now that the UK is no longer bound by the EU VAT rules, the existing zero-rating provisions for residential and charitable properties – including relevant residential properties such as student accommodation – could be widened, which would also help to simplify the rules.

The government could also take the opportunity to reform the VAT and property rules so that they are more aligned to achieving the UK’s climate change targets. For example, alterations and repairs to existing buildings could carry a lower rate of VAT than new builds. Currently, in relation to residential property, the VAT system zero rates the construction of a new building but standard rates the potentially more environmentally friendly option of upgrading an existing building.

Other uncertainties in the VAT system are entirely of HMRC’s making and do not relate to the legislation. For example, the unexpected announcement in September 2020 that the VAT treatment of early termination payments and other compensation payments relating to commercial contracts was changing with retrospective effect resulted in confusion as to how property contracts were affected. Although HMRC announced in January that the change would not be retrospective, we are still waiting for clarification as to how property transactions will be affected. The VAT treatment of dilapidation payments in relation to commercial leases is a particular area of concern.

The call for evidence is open until 3 August 2021. It is important that HMRC hears from those who could be affected by the changes and so businesses are encouraged to respond to the call for evidence.