UK government ‘still considering’ reform of VAT and property rules

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In a published response to May’s call for evidence to assess potential options for simplifying the land and property VAT exemption, the government confirmed that it would not proceed with a number of possible reforms. It has, however, said that it would like to explore two suggestions further: making short term interests in land subject to VAT; and making most supplies of land subject to VAT with a limited number of exceptions.

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, including new commercial buildings or specified short term interests such as hotel accommodation and car parking, are automatically standard rated, and some supplies in relation to residential property are zero rated.

Property tax expert Richard Croker of Pinsent Masons said: “It is surprising that the government is still considering the possibility of changing the rules to make supplies of land subject to VAT with a limited number of exceptions as it acknowledges in the response document that a clear majority of those responding to the call for evidence opposed this proposal”.

“This proposal would remove the option to tax, so would increase irrecoverable VAT for VAT exempt tenants and would make the regime much less flexible for landlords than it is currently. It is also not clear what the exceptions would be: relevant residential purpose properties, relevant charitable properties and dwellings are mentioned as situations where supplies ‘could continue to be exempt’, but it is not clear whether zero rating would continue to apply,” Croker said.

The government acknowledged in the response document that this proposal is “by far the most significant change of the potential options” and “the most challenging to develop and introduce in the short to medium term”. It said that it would like to understand these challenges more fully, along with any unintended consequences, before making any decisions, and stressed that it has not yet made any decision as to which option, if any, will be taken further. In addition, any significant changes to the VAT rules would require considerable further consultation and sufficient lead in times and transitional rules, the government said.

Responses to the proposal to define short term interests and make them subject to VAT were evenly split in support and opposition, the government said. 

Croker said: “Although defining short term interests sounds like a proposal which could eliminate some problems with the existing rules and result in more certainty, this depends on how the definition works and what the cut-off period is. It will be challenging to come up with a definition that is at once simple to apply and also fair to all. There is a risk that tinkering with the regime could result in further complexity”.

The government has confirmed that it will not proceed with three possible reforms previously considered and dismissed by the Office of Tax Simplification. 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. The government also rejected a further proposal to link the VAT liability of supplies of land and property interests to those that have been registered with the Land Registry, describing it as “ineffective, and probably inoperable”.

Most of those responding to the call for evidence were in favour of some simplification to existing VAT rules. However, there was also some opposition to simplification, with some respondents suggesting that they were comfortable with the current system because it continues to work well in most instances.

Further discussions with businesses are intended to begin in the early part of 2022 and may also cover establishing a more comprehensive and accessible register of existing options to tax and reviewing the anti-avoidance rules relating to the option to tax, as requested by some of those responding to the call for evidence.

HM Revenue and Customs (HMRC) is also intending to issue improved guidance on a number of areas including dilapidations, overages, call options and rights of light.

HMRC is due to publish updated guidance relating to dilapidation payments early next year. This follows 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 which resulted in confusion as to how property contracts were affected.

HMRC announced in January that the change would not be retrospective, and has been taking legal advice in relation to how dilapidation payments will be affected.

“Although we understand that HMRC has finally accepted that most dilapidation payments will not be subject to VAT, the revised guidance to reflect this is still awaited, over a year since HMRC caused consternation by its ill-thought through announcement last September,” Croker said.

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