VAT and Property Transactions: Navigating Costly Traps
Property VAT is one of the most complex and high-risk areas for businesses. The sums involved are large, the rules are technical, and the penalties for mistakes can be severe.
At ETC Tax, we regularly see avoidable VAT errors that lead to irrecoverable costs, HMRC disputes, or costly deal delays.
With this in mind, we have put together a checklist to help you avoid the most common traps.
The Option to Tax (OTT), Miss It and Pay the Price
Why it matters:
Opting to tax allows a business to charge VAT on rent or sales and reclaim VAT on associated costs (like refurbishments or legal fees). However, an OTT is only valid if properly made and recorded.
Check that:
The OTT has been formally notified to HMRC.
The landlord’s position is confirmed in writing.
Accurate records of the election are kept for future reference.
Common mistake: Assuming an OTT was made when it wasn’t. We often see clients who have incurred six-figure refurbishment costs, only to find their VAT claim rejected because no valid OTT was in place.
Tip: Always confirm OTT status before incurring expenditure.
Transfer of a Going Concern (TOGC), Relief or Risk?
Why it matters:
Where a property sale is part of a wider business transfer, VAT may not apply if the deal qualifies as a TOGC. This saves VAT on the purchase price and reduces SDLT, but only if strict conditions are met.
Check that:
Both buyer and seller are VAT-registered.
The property will be used for taxable business purposes.
Any Option to Tax is valid and in place.
Common mistake: Assuming TOGC applies without checking the conditions or obtaining VAT registration in time.
Tip: Confirm TOGC eligibility early; structuring errors can add millions to a deal.
Partial Exemption, Managing Mixed Supplies
Why it matters:
If your business makes exempt supplies (e.g. residential lettings, education, health, or finance), you may not be able to recover all input VAT. The partial exemption rules determine how much you can reclaim.
Check that:
The standard method of VAT recovery produces a fair result.
You’ve considered applying for a special method if the standard one is unfair.
Any special method is agreed with HMRC in advance.
Tip: Specialist advice can help negotiate fairer recovery rates and defend them in HMRC reviews.
Overlooked Areas, Deposits, Inducements, and Break Payments
Why it matters:
Payments such as deposits, lease inducements, dilapidations, and break fees can all have VAT implications. HMRC has become increasingly aggressive in challenging incorrect treatments.
Check that:
You’ve identified all side payments in the transaction.
You’ve clarified whether each payment is consideration or compensation.
VAT advice has been sought before contracts are signed.
Common mistake: Reviewing VAT treatment after signing agreements, when it’s too late to change the terms.
Tip: Early review avoids disputes and unplanned VAT costs.
Why Specialist VAT Advice Matters
Property VAT is too complex to rely on assumptions or generalist advice. Getting specialist input early protects both value and compliance.
Contract and lease reviews to confirm VAT treatment.
Advice on Options to Tax and TOGC eligibility.
Support with partial exemption calculations and HMRC negotiations.
Guidance on complex payments (deposits, inducements, break clauses).
Representation in HMRC disputes or recovery challenges.
Next Steps
VAT on property can be difficult to navigate, but with the right planning, most risks are avoidable.
Missed OTTs, incorrect TOGC assumptions, poor partial exemption management, or overlooked payments can all cost thousands, but with early specialist advice from ETC Tax we can safeguard VAT recovery and keep your transactions on track. Please get in touch to find out how we can support you.
Our client was buying land that the vendor thought was within the scope of an Option To Tax
The Issue
The addition of VAT to the sale price would make the transaction untenable, as the client would not be able to recover the VAT.
How we solved it
We reviewed documentation dating back to 2004, when the original Option to Tax was made to understand whether the scope of the Option had been fully defined. We also reviewed the VAT legislation that was in force at the time and identified arguments that would subsequently disapply the Option to Tax even if it had been in place.
The Outcome
We presented our arguments to the seller’s solicitors to enable the sale to proceed without a VAT charge being applied, a great outcome for our client.
Next Steps
If you have a case similar to the one above and want an expert opinion please do get in touch
The recently issued First-Tier Tax Tribunal (FTT) decision in the case of Realreed Limited raises the interesting question of determining when a taxpayer’s behaviour is ‘careless’ for the purposes of applying penalties in cases where an error has arisen and HMRC’s approach generally in terms of the VAT treatment of the supplies in question.
Realreed owns a property, Chelsea Cloister, containing 235 self-contained serviced apartments, which it lets to third parties. Related services such as maid service, dry cleaning, Wi-Fi, luggage storage and linen changes, were at all times provided by Chelsea Cloisters Services Limited (CCSL), a company under common ownership with Realreed.
Realreed was providing the accommodation element only. The question before the FTT was whether the supplies of accommodation were VAT exempt. Realreed believed so and treated them historically, or subject to VAT at the standard rate. This is now HMRC’s preferred analysis on the basis that the supplies were of hotel accommodation, or similar.
HMRC had carried out multiple VAT inspections of Realreed over the years. Despite this HMRC never challenged the VAT treatment of its supplies. This was the case until HMRC issued a liability decision dated 14 February 20. They took the view that Realreed’s supply of accommodation is subject to VAT at the standard rate. Subsequently, HMRC raised VAT assessments in the sum of £4.572m. HMRC also issued a penalty for careless behaviour, which was later suspended. Realreed objected to HMRC’s assertion that its behaviour was careless. Had HMRC attempted to enforce the careless penalty, this would have been at a cost of £685,800 to Realreed.
In relation to the VAT liability, the underlying question before the FTT was whether Realreed’s supplies are removed from the VAT exemption that applies to certain supplies of land and property. This was because its supplies are ‘the provision in an hotel, inn, boarding house or similar establishment of sleeping accommodation’. Realreed’s contention was that it made supplies of accommodation only and if evaluated separately from CCSL’s supplies of services. Realreed’s supply contained none of the additional elements involved in supplies of an establishment similar to a hotel, inn or boarding house.
Although the FTT accepted that Realreed was only supplying the property element of the serviced accommodation, it concluded that the ancillary services provided by CCSL should be taken into account when considering whether Chelsea Cloister was an establishment similar to a hotel. As a result, the FTT took the view that because the majority of Realreed’s customers stayed for less than 28 days, in conjunction with the additional services supplied by CCSL, Chelsea Cloister was establishment operating in competition with hotels.
Whilst the VAT liability issue will be of interest to anyone operating in the accommodation sector, the penalty appeal is likely to be of wider interest and should be carefully considered by all businesses. The penalty was suspended by HMRC meaning the outcome of the penalty appeal had no financial impact on either party. Where a penalty is suspended it is only payable by the taxpayer if conditions laid out by HMRC are not met. Nevertheless, Realreed wanted to pursue this point, asserting that HMRC was not entitled to issue a penalty in the first place, because Realreed’s behaviour could not be considered careless.
HMRC had carried out multiple inspections over the years without querying the VAT treatment of Realreed’s supplies. Realreed’s submission was that it acted reasonably and diligently, and submitted VAT returns consistently with what it believed to be the correct VAT treatment, endorsed by HMRC’s actions during previous inspections. HMRC never challenged the VAT treatment, nor did it recommend seeking specialist advice on the proper VAT treatment of supplies. As a result Realreed took the view it was reasonable to derive substantial comfort from the outcome of HMRC’s inspections and it had no reason to think it had done anything wrong.
The FTT found that whilst the business has not fundamentally changed since 1991, there were sufficient changes in its operation that a person taking reasonable care would wonder whether the VAT position has changed. The last evidence of Realreed taking professional advice on the VAT position dates back to 1991. As VAT is a fast-evolving tax, the FTT thought it would be unreasonable to assume the VAT treatment of a specific supply would not evolve over 30 years. The FTT held that Realreed did not take any professional advice after 1991, it did not carry out any internal analysis and betrayed no intellectual curiosity about its VAT affairs. Realreed simply accepted the advice from 1991 and did nothing since to validate this advice in subsequent years.
The FTT concluded that Realreed didn’t exercise the level of diligence and care that a reasonable taxpayer would take. As a result the penalty, whilst no longer having any financial impact on Realreed, was correctly issued by HMRC.
This case raises the question of how much comfort can be taken from a VAT inspection where queries are not raised as to VAT treatments applied and should be viewed as a reminder to any business that believes it is safe from VAT assessments and penalties because it has a history of “clean” VAT audits.This puts taxpayers in a difficult position because there is no guarantee that HMRC will not seek to challenge any particular VAT treatment at a later date.
Next Steps
It is recommended that businesses refresh VAT accounting policies and procedures regularly. Where there are any areas of ambiguity, guidance should be sought. Support from ETC Tax or HMRC via a non-statutory clearance application is recommended. Please do get in touch for further assistance.
VAT & Property – Working with Developers and Investors to Maximise VAT reliefs
Introduction (VAT)
Our client had acquired an existing block of flats with the intention of refurbishing for rental. Our Client wanted to minimise property VAT costs on the acquisition.
What was the issue
The issue with this was the VAT costs would be irrecoverable, the question for us being – how do we minimise these costs?
How we solved it
We identified areas where the 5% VAT rate and 0% VAT rate could be applied and advised the client accordingly. We drafted a technical note to support the treatment that the client shared with the contractors to ensure that the lower rates of property VAT were applied to their invoices.
The outcome
The client significantly reduced the level of irrecoverable VAT that they paid.
Next Steps
Does this case sound familiar to you and your situation? Do you need further VAT advice? please do get in touch
Q: My company isn’t VAT registered because all we do is buy, renovate and rent out/sell old residential properties. We pay VAT on the refurbishment costs and this an additional cost because we can’t VAT register to recover it. There’s not much we can do about it, so there’s not a lot to discuss regarding VAT, is there?
A: In certain circumstances, it is possible to register for VAT, even if you only deal in residential investments.
It is correct that because the rental of residential property is a VAT exempt activity. It is not normally possible to recover VAT incurred on relate costs.
Certain VAT reliefs available…
However, there are certain VAT reliefs available to limit the amount of irrecoverable VAT you will incur.
I.E the 5% reduced rate of VAT can be applied to renovation works in a number of circumstances. Such as, if the property has not been occupied for residential purposes in the two years before the work begins. Or, if the work entails a change to the number of dwellings.
Similar VAT reliefs are also available where a non-residential property coverts into a residential property. Additionally, the long-lease or sale of residential property could mean it will be possible to obtain a VAT registration. This also means the VAT you incur is recoverable. The same can apply if a residential building that has been unused for more than 10 years undergoes renovation.
Q: 5 years ago in 2018, my Company bought the small office building that it was occupying as a tenant. The Company bought it from the landlord for £500k plus £100k VAT. My Company recovered the £100k VAT because it was only using the property for its own (fully taxable) business.
We now need to move into bigger premises so we are selling the office building in March 2023. We have never opted to tax the property because our accountant told us we didn’t have to. This isbecausewe’ve only used it ourselves for fully taxable purposes, so we could sell it without VAT.We recovered all of the £100k VAT we paid on its purchase and the sale will be VAT exempt because we haven’t opted to tax. However, our accountant told us that HMRC cannot claw back any of the VAT we recovered on the purchase.They saidwe recovered the VAT more than four years ago, and this was therefore outside the 4 year time limit for assessing VAT.
This sounded reasonable to me, but a friend of mine that I trust said that it didn’t sound right and suggested that I got a second opinion.
HMRC clawing back some of the VAT!
A: You were right to listen to your friend. Your accountant was right to say that you didn’t need to opt to tax the building to recover the VAT. This is because you were occupying it for fully taxable purposes. However, they were wrong about HMRC not being able to claw back some of the VAT you initially recovered.
Although HMRC cannot make any adjustments to the original recovery because:
(a) it was correctly recovered at the time
(b) it’s more than 4 years ago since the VAT was recovered in any case, there is a mechanism that HMRC can use to claw some of it back in a later period if the basis on which the VAT was recovered subsequently changes. This is called the VAT Capital Goods Scheme (the ‘CGS’)
Capital Goods Scheme (CGS)
The CGS applies to land, buildings, or construction works that, when you purchase, are a value of £250k or more. The buildings were also subject to VAT. There is also a version that relates to computers but this is much less common than the property CGS.
In this case, the CGS will apply because the purchase of the building was more than £250k and they can collect VAT.
Under the CGS, the initial recovery (at the time the VAT is first incurred) follows the normal rules. So, it was correct to fully recover the £100k VAT. This is because, at the time, they were using the building d 100% for taxable activities by the Company.
However, they review the ‘taxable use’ of the building in each subsequent year for the next 10 years, and if in any year the extent to which they use property for making taxable supplies is different from how it uses in the year they initially incur the VAT, adjusts must be made.
The amount of VAT that is subject to potential adjusts each year is 10% of the VAT that they initially incur on the CGS item (so in this case, £100k x 10% = £10,000.)
If taxable use decreases, it will be necessary to pay back some of the VAT originally recovered.
If taxable use increases, it will be possible to recover an additional portion of the VAT originally incurred.
Calculation
The first calculate the change in taxable use (as a % increase or decrease) between the year you are making the calculation and the initial period in which you incur the VAT. This +ve or -ve % applies to the £10,000 (in this case) to arrive at the adjustment required.
If a property sale goes through part-way through the 10-year CGS period, the remaining ‘intervals’ will ‘crystallise’ and only require a single adjustment. They base this on the number of years left in the 10-year CGS period, with the VAT liability of the sale being the ‘use’ to which the property is put when they finally calculate.
So if you sell the property (as VAT exempt) 5 years into the 10-year period, the final adjustment will be 5 x annual adjustments in one. The total CGS calculation would look like this (£100,000 VAT recovered in year one):
Period Taxable Use Change in taxable use CGS adjustment required
(compared to year 2018)
Year to 2018 100% n/a n/a
Year 2 (2019) 100% 0% £10,000 x 0% = nil
Year 3 (2020) 100% 0% £10,000 x 0% = nil
Year 4 (2021) 100% 0% £10,000 x 0% = nil
Year 5 (2022) 100% 0% £10,000 x 0% = nil
Year 6 (2023) 0% -100% £50,000 x -100% = -£50,000
Conclusion
If you opt to tax the building prior to its sale the recovery % would be 100% (same as when you bought the building). No adjustments are required. Although, you would have to charge VAT on the sale price.
Next steps
Do you have any VAT property questions? do not hesitate to get in touch
What happens when a property developer’s plans change?
We regularly engage with property developers. Usually, to help them get the most out of their projects from a VAT perspective. Typically, advising on the availability of VAT reliefs to minimise the amount of VAT paid and/or minimise restrictions to the recovery of any VAT payable). Most developers will be aware that the ability to recover VAT on build & professional costs rests on being able to attribute those costs to ‘taxable activities.’
For example…
The sale (or long lease) of a new house or apartment is a (zero-rated) taxable activity. Generally, this enables the recovery of any VAT paid on related costs.
However…
If the intention is to rent a new property out on a short term let, this is a VAT exempt activity. Which normally means that the VAT incurred on related costs is irrecoverable (thus becoming a further cost to the project).
So, the VAT position is relatively clear if the intention is taxable (full VAT recovery) or VAT exempt (no VAT recovery).
What then…
If you start off with the intention to make taxable supplies (e.g. sale of the houses/apartments you are developing), to fully recover the VAT incurred on build costs. It may mean adverse market conditions mean that you need to defer selling the properties. So, you have to rent them out instead (VAT exempt) at least until such time market conditions are more favourable.
Many developers found themselves in this position in the late 2000s when there was a significant downturn in the housing market. It appears that developers are once again finding themselves in a similar position.
Say a taxpayer fully recovers VAT on the basis that they intended to make taxable supplies. They actually make VAT exempt supplies before their taxable intention is fulfilled. The VAT regulations (regulation 108) call for repayments to HMRC for recovered VAT. Only fully if the taxpayer now only makes VAT exempt supplies; partially if they now make both taxable and exempt supplies.
The clawback!
When developers started to rent out properties 25 years ago they had intended to sell, HMRC started issuing assessments to ‘clawback’ the VAT. The VAT was recovered by the developers (regulation 108 is normally referred to as the ‘clawback’ provisions.)
In reality
One of my clients, at the time, is faced with such a predicament and asked if there was anything to be done.
I told them ‘yes’ because there had been two cases a few years earlier (Curtis Henderson and Briararch) that we could use to challenge HMRC’s assessment. The cases are heard together because they deal with the same issue:
What to do if VAT had been recovered on the basis of a taxable intention but VAT exempt supplies were made before the taxable supplies were made, but the intention to make taxable supplies, although delayed, still existed.
The Curtis Henderson/Briararch judgement found that if VAT was recovered on the basis of an intention to make taxable supplies and the intention remained in place, so did the right to recover related VAT costs, although any VAT exempt supplies made would also need to be considered, with the recovery of VAT costs restricted to the extent they are attributable to the VAT exempt supplies.
The principles are set out in the earlier cases, but…
How do we work out how much if any VAT is recoverable/repayable?
After much negotiation with HMRC we arrived at a simple calculation. The calculation compares the time the property is rented out to the ‘economic life’ of the property. HMRC apply this ratio to the recovered VAT in relation to the development of the properties. We used this calculation to establish whether the value of VAT attributable was below the partial exemption ‘de minimis’ limit (and therefore fully recoverable as being immaterial).
This initial check showed that the VAT costs attributable were above the ‘de minimis’ limit. We then carried out a more detailed calculation using anticipated sale values & rental income values. This shows the expected income it generated from the properties over their 10-year ‘economic life.’ We initially argue that the economic life should be 25 years. However, HMRC insisted that it should be in line with the 10-year Capital Goods Scheme.
Our client accepted this because the second calculation showed that the level of VAT attributable to the VAT exempt lets was below the ‘de minimis’ limit and thus fully recoverable.
Shortly after we conclude the matter, HMRC issue a VAT Information Sheet (07/08) (in September 2008). This confirms methods not too dissimilar to those we agreed with them could be used by any developer. Thankfully, without having to seek approval from HMRC.
We recently used this methodology for a client who had converted a number of industrial buildings into dwellings. To raise some funds for the completion of the project, they rent completed units. HMRC were about to clawback £80k from our client. This was until we submitted a calculation that showed that the value of VAT attributable to the exempt lets. The calculation taking in to account future sales, was below the de minimis limit.
We use similar methodologies for ‘Rent To Buy’ arrangements. These are similar to those described above except the initial rentals are part of a wider agreement with tenants/buyers. A planned exempt rental period should not make a difference. This is, provided there remains an intention to make a taxable sale after the initial rental (whether to the people renting the property or a third party). There are other important factors to consider for Rent to Buy arrangements that may have a VAT impact:
receipt of grant income, the VAT treatment of which will depend on the terms under which the grant funding is provided.
In Conclusion
Finally, note that there are other structuring ways for VAT exempt rental activities (including more permanent renting activities). This is so that VAT costs are fully recoverable. But in principle, VAT costs relating to residential rental properties are normally irrecoverable.
