HMRC announced in the June 2010 Budget that the standard rate of value added tax (VAT) would increase from 17.5 per cent to 20 per cent with effect on and from 4 January 2011.
The supply of real estate (that is, the sale or lease of land) is exempt from VAT unless the supplier (the seller or the landlord) has opted to tax the land. It is only possible for a person to opt to tax non-residential land.
The increased rate will have two main effects on property transactions where the landlord or seller has opted to tax the land. First, it will alter the VAT which the seller or landlord should charge; secondly it will alter the amount of stamp duty land tax (SDLT) payable by the buyer or tenant.
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Which rate of VAT should I charge?
Sale of freehold or leasehold interests
The question of which rate of VAT should be applied will depend upon the time that the supply is made. Where the time of supply is prior to 4 January 2011, VAT at 17.5 per cent should be charged. Where the time of supply is on or after 4 January 2011, VAT at 20 per cent should be charged.
The time of supply on a sale of a freehold or leasehold interest is generally the date of completion. However, this can be brought forward if a VAT invoice or payment is received earlier, or delayed if a VAT invoice is issued within 14 days of completion. As a result, if the sale of a freehold or leasehold interest which the seller has opted to tax completes before 4 January 2011, VAT at 17.5 per cent should be charged unless the seller issues a VAT invoice after 4 January 2011 (but within 14 days of completion), in which case the time of supply is the date of the invoice and VAT at 20 per cent should be charged. However, as completion takes place prior to 4 January 2011, the seller can choose to apply the special rules for sales that span the change in rate and instead charge VAT at 17.5 per cent despite issuing an invoice after that date.
If completion of the sale of a freehold or leasehold interest takes place on or after 4 January 2011, VAT at 20 per cent will be chargeable. It is unlikely that the time of supply can be brought forward in order to take advantage of the 17.5 per cent rate by issuing a VAT invoice or making payment before 4 January. This is because VAT anti-forestalling legislation may apply, resulting in a 2.5 per cent supplementary charge to VAT (thereby resulting in a total VAT cost of 20 per cent). However, where a deposit is paid as agent rather than stakeholder, the time of supply in respect of that deposit will be at the time it is paid.
Payment of rent under a lease
Where a landlord has opted to tax land which it leases so that VAT is charged on the rent paid by the tenants, the time of supply of the rent for VAT purposes is each time a VAT invoice is issued or a rental payment is received, whichever happens first. If the tenant pays rent in advance prior to 4 January 2011 (or the VAT invoice is issued prior to 4 January 2011) and the rental period to which the payment relates spans 4 January 2011, the landlord can either charge VAT at 17.5 per cent on all of the rent for that period, or they can choose to charge VAT at 20 per cent on the rent incurred for the period from 4 January 2011.
If the tenant pays rent in arrears on or after 4 January 2011 (or the VAT invoice is issued on or after 4 January 2011) and the rental period to which the payment relates spans 4 January 2011, the landlord can either charge VAT at 20 per cent on all of the rent or they can choose to charge VAT at 17.5 per cent on the rent incurred for the period prior to 4 January 2011.
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Impact on SDLT
SDLT is payable on the consideration paid for a property transaction. When calculating the amount of SDLT due, the amount of VAT payable must be added to the consideration. As a result, the amount of SDLT payable on a property transaction will increase once the VAT rate increases.
On the grant of a lease SDLT is payable at 1 per cent of the net present value of the VAT-inclusive rent payable throughout the term of the lease. When calculating the net present value, the rent payable over the first five years of the lease is used and the rent payable for years six and onwards is assumed to be the highest rent payable in years one to five. If the rent payable in the first five years is uncertain or variable - for example a rent based on turnover - the SDLT must be calculated on a reasonable estimate of the rent payable in this period. Once the rent becomes ascertained or, if earlier, the first five years of the lease end, the SDLT must be recalculated based upon the actual rent paid in the first five years. Any additional SDLT must be paid to HMRC and a further SDLT return must be submitted.
HMRC announced on 5 October 2010 that they will not regard a lease upon which VAT is charged as having an uncertain rent merely because of a change in the rate of VAT. Therefore, subsequent changes to the VAT rate will not affect the initial SDLT calculation. As a result, tenants with leases with an effective date before 27 July 2010 (the date on which the legislation introducing the increased VAT rate came into force) will not be required to submit a further SDLT return or pay SDLT on the additional VAT they will be paying under the lease. The only exception to this is where the rent itself is uncertain or variable, when a further SDLT return would be required in any event.
Where a lease has an effective date on or after 27 July 2010, the SDLT calculation should take into account that the VAT rate will be 17.5 per cent for rent payable on a date prior to 4 January 2011 and that VAT at 20 per cent will be payable for rent where the rental payment date falls on or after 4 January 2011.
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HMRC initially announced in early August 2010 that any lease upon which VAT is charged has uncertain rent, so that tenants with leases granted since 4 January 2006 would need to revisit their SDLT calculations. However, this initial announcement was withdrawn pending further consideration prompted by the reaction to the administrative burden that it would have placed on tenants.
HMRC’s revised announcement on 5 October 2010 is very welcome as the additional SDLT which would have otherwise become payable when the VAT rate increased would be minimal and would be far outweighed by the administrative burden and cost to tenants in recalculating SDLT and submitting further SDLT returns.
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