VAT on commercial property explained

Why VAT matters on a commercial purchase

Most sales and lettings of land and buildings are exempt from VAT, which means no VAT is charged. With commercial property, two common situations change that: the building is new, or the owner has chosen to charge VAT by opting to tax.

VAT at the standard rate of 20% turns a £500,000 price into £600,000. That changes the cash you need on completion, the property tax you pay and the wording of the contract. Whether you can get the VAT back depends on your own VAT position.

This guide explains the main rules for buyers in plain terms. VAT is an area where your solicitor often works alongside your accountant or a VAT specialist, so involve both early.

When VAT is charged

HMRC's guidance in VAT Notice 742 says a sale or lease of land and buildings is normally exempt. The main exceptions for a buyer are:

• the freehold sale of a new commercial building, which is standard-rated (charged at 20%) if it was completed less than three years ago or is only partly built
• any sale of a property the seller has opted to tax
• a lease of a property the landlord has opted to tax, where VAT is added to the rent

For example, the freehold of a warehouse finished 18 months ago carries VAT whatever the seller prefers. The freehold of a 1990s office block is exempt unless the seller has opted to tax. New homes sold by the builder are generally zero-rated, meaning VAT is charged at 0%. VAT Notice 742 has the detail.

The option to tax and how to check it

An option to tax is an owner's choice to charge VAT when it sells or lets a particular property, usually so it can reclaim VAT on its own costs. It covers the whole building and its land, must normally be notified to HMRC within 30 days of the decision and generally lasts at least 20 years. It can be revoked within six months in limited cases, and lapses if the owner has held no interest in the property for six years.

The option belongs to the owner who made it. It does not pass to you when you buy, so you decide separately whether to opt yourself.

Your solicitor asks the seller, through the standard pre-contract enquiries (the questions raised before exchange), whether the property is opted to tax, and asks for a copy of the notification and proof that HMRC received it. Since February 2023 HMRC has not sent acknowledgement letters, although a notification sent by email gets an automatic receipt, so the seller's own records matter. The answer decides whether the price is plus VAT, and VAT Notice 742A sets out the rules.

Transfer of a going concern

If you buy a let property and will carry on letting it, the sale may be a transfer of a going concern, or TOGC. It is then treated as the transfer of a business, so no VAT is charged even if the seller has opted to tax or the building is new. In simple terms, the main conditions are:

• you take over the same kind of business, such as a building sold with its tenants, and carry it on without a significant break
• you are VAT registered, or will be by the date of the transfer
• you opt to tax the property yourself and notify HMRC no later than the relevant date, usually completion, or exchange if the deposit goes to the seller instead of a stakeholder, a neutral holder who keeps it until completion
• you confirm to the seller that your option will not be disapplied under an anti-avoidance rule

An empty building still being marketed to find a tenant is not normally a TOGC, and nor is a sale to the tenant of the whole building. If the conditions are missed, VAT becomes payable, and the contract will usually let the seller add it to the price. VAT Notice 700/9 explains the conditions in full.

How VAT affects your cash and property tax

VAT is paid with the price on completion, so you need the cash or funding for it even if you can reclaim it later. Check whether your loan is based on the price with or without VAT, and allow for a gap of weeks or months before a reclaim is repaid.

Property tax is worked out on the VAT-inclusive price, and that extra tax is not refunded when you reclaim the VAT. Take an office bought for £400,000 plus £80,000 VAT, £480,000 in all, at the non-residential rates:

• England or Northern Ireland: Stamp Duty Land Tax is 0% on the first £150,000, 2% on the next £100,000 (£2,000) and 5% on the remaining £230,000 (£11,500), a total of £13,500, against £9,500 on the price without VAT
• Wales: Land Transaction Tax is 0% to £225,000, 1% to £250,000 (£250) and 5% on the remaining £230,000 (£11,500), a total of £11,750

In England or Northern Ireland, the VAT adds £4,000 of tax here that you will not get back. On a TOGC there is no VAT, so the tax is worked out on the price alone.

Recovering VAT if you are VAT registered

If you are registered with HMRC for VAT and will use the property in a business making taxable sales (sales that carry VAT, including at 0%), you can usually reclaim the VAT on your VAT return. A retailer or manufacturer buying its own premises is often in this position. It is less simple when:

• your business is mainly exempt from VAT, as with many financial, insurance and medical services, so you may recover only part of the VAT, or none
• you are buying to let, because you normally need to opt to tax yourself to reclaim the VAT, which then means charging VAT on the rent, a real cost to tenants who cannot reclaim it
• your use of the building changes later, because on larger purchases the capital goods scheme can require you to adjust the VAT reclaimed over up to 10 years

If you are not VAT registered, the VAT is simply part of your cost. Ask your accountant to confirm your position before exchange.

Residential conversions and charities

Different rules apply where a building will be used as homes or by a charity. These are specialist areas, but the headlines are:

• an option to tax does not apply to a building designed as a dwelling
• if you are buying a commercial building to convert into homes, you can give the seller a certificate on form VAT1614D so their option does not apply and the sale is exempt; it must be given before the price is legally fixed, usually at exchange
• a charity that will use a building solely for non-business charitable activities, other than as an office, can tell the seller before the sale so the option does not apply
• some new buildings for residential or charitable use can be zero-rated if strict conditions are met

For a developer buying an opted office block for £500,000 to convert into flats, a certificate given in time avoids £100,000 of VAT and reduces the property tax. Give it after the price is fixed and the seller does not have to accept it.

Checklist: why VAT advice must come early

Most VAT problems come from questions asked too late. Raise VAT when you agree heads of terms, the summary of the main deal points:

• ask whether the price is plus VAT, and whether the building is new or opted to tax
• if the sale could be a TOGC, register for VAT and opt to tax in good time
• give any VAT1614D certificate before the price is fixed if you plan to convert to homes
• check your funding covers the VAT and the property tax on the VAT-inclusive price
• ask your accountant whether you can reclaim the VAT

Your solicitor raises enquiries about the seller's VAT position, checks the evidence, negotiates the VAT clauses in the contract and calculates the property tax. Your accountant or VAT adviser deals with your VAT registration, any option to tax of your own and recovery. You make the decisions and make sure everyone has the facts in time.

Next steps

A commercial purchase quote from Keyfolio gives an itemised estimate of the legal costs and the property tax. The tax estimate uses the price you enter, so tell the law firm if VAT will be charged and it can work out the tax on the VAT-inclusive figure. The firm confirms its quote in writing before you instruct it.

Selling as well? See commercial property sales, or read more about our commercial property services.