Simplifying the VAT land exemption

HMRC has published a summary of responses to its recent consultation asking for stakeholders’ views on possible reforms to the VAT exemption for supplies of land and property.

In its consultation document, Simplifying the VAT Land Exemption – call for evidence, HMRC identified the growing number of exceptions to the land exemption, along with the rules and processes for applying the option to tax to some supplies that would otherwise be treated as exempt from VAT, as areas of particular complexity for organisations dealing with VAT on real estate. Respondents broadly agreed that, whilst cautioning against sweeping changes, targeted simplification would be welcome, with some constructive proposals emerging for the way forward. However, the real estate sector and its customers should potentially be concerned by HMRC’s interest in a model which could feasibly remove the VAT exemption from all supplies of land and property other than that put to a residential or charitable use.

Summary of responses

The responses, including RSM’s comments, are summarised at Simplifying the VAT Land Exemption - summary of responses. Having considered respondents’ views on the range of reform options presented, HMRC has narrowed these down to four possible changes which it intends to explore further, being:

• making short term and minor interests in land and property subject to VAT;
• establishing a more comprehensive and accessible register of existing options to tax - there is currently no facility for taxpayers to check whether a supplier has opted to tax a particular property, leading to uncertainty over its true final selling price;
• reviewing the anti-avoidance rules relating to the option to tax, an exceptionally complex area of VAT law; and
• removing the option to tax altogether and making supplies of land and property subject to VAT by default, with a limited number of exceptions (eg for residential accommodation and buildings used for a charitable purpose).

Other HMRC comments

HMRC does not intend to take any further action regarding any of the potential options for change that were previously considered and discounted by the Office of Tax Simplification (OTS) in its 2017 VAT review (such as changing from an ‘option to tax’ system to an ‘option to exempt’ system) and has also dropped its earlier suggestion of linking the VAT treatment of a property to whether it is registered at the relevant Land Registry. HMRC agrees with the OTS and respondents that those options are unlikely to effectively tackle the overall complexity of VAT as it applies to land and property.

HMRC also acknowledges in the response document that its guidance for VAT on land and property could be significantly improved. It has set up a working group with sector representatives with the aim of producing better guidance on four specific issues: dilapidations, overages, call options and rights of light. Work is already underway on to produce guidance on dilapidation payments and overages. The treatment of dilapidations is already part of an ongoing review of HMRC’s VAT policy on early termination charges and compensation payments and would appear to be HMRC’s top priority when improving its guidance.

What does this mean for the property sector?

Broadly speaking, HMRC has listened to the concerns raised by respondents. We welcome its decision to flag the complexity of the option to tax anti-avoidance rules and the need for an option to tax database for further scrutiny. It also seems wise to review the VAT treatment of short-term and minor interests in land as this has led to significant uncertainty and complexity in establishing the correct liability, especially for sports lettings and car parks. An overhaul of HMRC’s land and property VAT guidance is long overdue.

We are also pleased to see that HMRC has ruled out several reform options it set out in the consultation that were generally considered by respondents to be unsuitable, but we are concerned that it has not ruled out the proposal to remove the option to tax and impose VAT on most land and property, despite a clear majority of respondents opposing this suggestion.

Imposing VAT on supplies of land and property in this way would remove the helpful flexibility that the current option to tax offers and leave organisations that cannot recover all their VAT with a considerable additional tax burden when buying or renting property. There would also be a very difficult period of transition from the current system for the whole sector and its customers. HMRC should expect strong objections to this model in the next phase of stakeholder engagement.

What happens next?

HMRC stresses that no decisions have yet been made on whether any of the four options it has selected for further consideration will be adopted and says that it wants to explore them in more detail with stakeholders to more fully understand the challenges and any unintended consequences of putting them into effect. It intends to begin further discussions with businesses in early 2022. Although HMRC does not specify what form these discussions will take, it seems likely that a second phase of consultation will be undertaken before any particular proposals are confirmed.

Those that own, rent or otherwise deal with land and property should watch out for further developments and consider getting involved with any follow-up consultations.

For more information, please get in touch with Ian Carpenter, or your usual RSM contact.