I regularly receive queries about owner managed businesses and property purchases. They cover a wide range of situations but generally cover two main subjects. The first is whether the VAT on the purchase and other costs can be recovered; and second whether the VAT can be recovered if the property is owned by someone other than the VAT registered business which occupies the property.
The short answer is that in principle it is possible for the purchasers to recover the VAT, but it depends on a number of factors and will probably require setting up a lease or licence between the new property owner and the occupying business.
Typical scenarios
Typical situations include queries where the main trading company/partnership can’t get the funding to purchase a property, so one of the directors or partners takes out a mortgage in their own name, or alternatively they set up a separate property company which purchases the company. In one case concerning a VAT registered husband and wife partnership, the wife had to purchase the property in her name as the partnership couldn’t get the mortgage to buy the property. In another case, a director of a limited company had to take out the mortgage and purchase the property in his name even though it is the company who will occupy the premises.
In all of these cases, VAT was paid on the purchase of the property and the purchasers wanted to know if they could recover the VAT and if so, how to do it. The logical thing for VAT purposes would normally be for the company/partnership to purchase the VAT but in the case of OMBs, there are often important non-VAT or even non-business reasons driving major decisions, so we have to manage the VAT angles to take these into account.
The VAT rules
There are two fundamental VAT things to remember about these situations.
- VAT can only be recovered by the purchaser. It can’t be recovered by a separate legal entity even if the purchaser of the property is a related company or director/partner of the trading entity.
- In any case, VAT on the purchase of any property can only be recovered if and to the extent that the property concerned is used to make supplies that are taxable for VAT purposes.
Now these are actually fundamental VAT rules that apply to the treatment of VAT on any costs, but they are particularly relevant for these scenarios. So in the case of our partnership, the wife is the only person who is entitled to recover the VAT or in the case of the limited company, the director. And only then if she/he is registered for VAT and using the property to make taxable supplies. And this is where things get complicated.
In practice, when properties are owned by a separate legal entity to the trading business, the owner will typically grant a lease or licence to enable the trading partnership/company to occupy the property in return for a commercial rent. However leasing commercial properties is exempt from VAT and under basic VAT principles, a business owner isn’t able to recover VAT on the cost of goods or services used to make taxable supplies. This means that in principle it isn’t possible for property owners to recover VAT on the purchase of properties or any other costs, such as repair, conversion or maintenance where the supply of the property is exempt.
Opting to tax
However it is possible for the property owner to recover VAT on the purchase of the property if they register for VAT and “opt to tax” the property. This means that their supplies of the property become taxable rather than exempt and they charge VAT on the rent for the property to the partnership.
The rules on opting to tax are complex and there is a very short introduction to the subject in my article on the forum here https://vatexchange.co.uk/forum_recovering_VAT_on_commercial_property_costs. More detailed information can be found in the HMRC VAT Notice 742a: “Opting to Tax land and property”, which is here http://tinyurl.com/3g32uz on the HMRC website. It is a difficult subject and you have to take into account the potential application of several complex VAT rules, including partial exemption, the “Capital Goods Scheme” and the “clawback/payback” provisions, never mind the detailed option to tax rules themselves.
There are some situations in which it is not possible to opt to tax or when the option is “disapplied”. These mostly apply to domestic properties, certain charitable and residential properties. There are also anti-avoidance provisions which prevent the option to tax when the user/tenant of the property is partly exempt so you have to take into account the VAT profile of the end user of the building before you can even establish whether it’s possible to opt to tax. And even if the option to tax can be made, there are very strict rules about when and how to make an option and if you get just one of these wrong, it can mess everything up.
Limited or not?
I’m often asked if it would be possible or advisable for a property owner to transfer the property to a separate limited company – ie a separate company to the trading company – so that the individual doesn’t bear the risk of owning the property. The property company could own the freehold and lease the property to the trading company in return for a normal market rent.
For VAT purposes, it doesn’t make any difference for VAT purposes whether or not the property is owned and opted by a sole proprietor or limited company – the VAT rules apply regardless of the legal status of the owner. So there are no specific VAT reasons for transferring the ownership to a limited company. The risk issue from a VAT point of view is if the property owning company defaults on its VAT payments, in which case HMRC could include the property in any action against the company to collect the outstanding debts. Of course this could be a real concern, especially if the trading company is struggling financially, but unless this is a real issue it wouldn’t serve any real benefit to the overall VAT position.
However, there may be other tax, funding or legal issues to consider, particularly for OMBs, so again you should take advice from your accountant and solicitor. It’s worth remembering that transferring the property ownership after the initial purchase would simply add further costs because in the form of the legal and potential Stamp Duty Land Tax costs. The original purchaser, ie the partner or director, would have to sell the freehold to the property company which would then lease the property to the partnership or trading company.
In order to recover the VAT on the original purchase, the partner/director would still have to register for VAT and opt to tax the property, then charge VAT on the sale of the freehold to the property company (unless it’s sold as a transfer of a going concern – see below). The property company would register for VAT and opt to tax the property and would enter into the occupational lease with the partnership.
The property company would also require its own VAT registration, have its own accounting records, bank account, audit and submit tax returns simply to avoid the possibility of HMRC claiming against the property in the event of the trading company defaulting or going insolvent.
So there would be a lot of additional work involved just in the course of transferring ownership of the property for no perceivable VAT benefit.
Transferring a property rental business?
There is also another important factor to consider. If the original purchaser (ie the partner or director) had already granted the occupational lease to the partnership or trading company before selling the freehold to the property company, then the sale of the freehold to the property company may qualify as the “transfer of a going concern” (TOGC).
This would be the sale of a property rental business as a going concern and in these situations, the sale of the property would not be liable to VAT even if both the vendor and purchaser has opted to tax the property.
The TOGC rules are particularly complex when applied to property sales and the transactions would have to be carefully managed to ensure that the TOGC treatment applies and the parties involved don’t end up incurring unnecessary VAT or other costs. Further information on this subject is in VAT Notice 700/9/2008: Transfer of business as a going concern, which is on the HMRC website.
But if there are other non-VAT reasons for transferring the ownership of the property to a limited company, then it might be worth considering. An individual partner or director probably may not want the long term risk of owning a property so this may be a valid reason on its own account.
In conclusion
There are situations when VAT is one of the main drivers in reaching business decisions and clearly the VAT cost of any commercial property is a cost that business owners will want to recoup, wherever possible. If the only way that a business owner can get the funding to purchase a new property is for an individual director/partner to take out a mortgage, then the only way that the VAT can be recovered is for the director/partner to opt to tax the property sell or lease the property to the trading entity (unless of course it’s a freehold sale of a property up to three years old in which case the sale would automatically be standard rated).
Major decisions relating the financial/tax aspects of a business shouldn’t be made in isolation and it’s important to look at all of the issues that might apply. Because the law on VAT and property is so complicated, I always recommend that you take formal advice on these issues. This is why:
- The amount of money involved in buying property is large and you need to protect your interests by obtaining proper professional advice.
- The rules about VAT and property are very complex and I can only mention the main issues here.
- Each set of circumstances is unique and there are any number of variables that could affect how you decide to proceed. Changing any small detail of the deal could have significant VAT implications.
Your accountant and solicitor know your circumstances better than I do and should be able to help with most of the main VAT and property issues, and hopefully they will also know if you need specialist advice.
October 2010