Protecting VAT cash flow on commercial developments

It is currently a challenging market for commercial developers. And any change in intention, from the sale of a new commercial property to a short term letting, may give rise to an unintended VAT cost to the developer.

The coronavirus outbreak has meant that a number of commercial developers of partly completed, or completed, new commercial developments may need to consider the options available to them in order to maximise the return on their investment. This article outlines the VAT implications related to one option for commercial developers to consider if they are facing difficulties in finding a buyer; by creating a short-term tenancy.

The sale of any newly constructed commercial property, at any time within three years of its completion, is automatically subject to VAT at the standard-rate of 20 per cent. 

But what if a buyer can’t be found in those early years, but a prospective tenant can? If a decision is made to lease it in the short term, rather than immediately sell, as was originally intended, the rental payments would be exempt from VAT. 

Should the developer consider opting to tax its interest in the property, a decision that could bind its VAT position for 20 years? By Opting to Tax the property, the developer ensures it retains the right to full VAT recovery on the costs of the development. However, this would not be the case if an Option to Tax wasn’t exercised. If an Option to Tax wasn’t exercised, the lease charges would be exempt from VAT and the developer would not be able to ensure it retains its original right to full VAT recovery on the costs of the development. Instead, it would have created a VAT liability (cash cost) to repay to HMRC an element of (or perhaps all) of the VAT it had originally claimed on the development.

As you can see, any change in intention by the developer of a new commercial property between sale and letting may give rise to a potential VAT cost, which may or may not be mitigated by being able to opt to tax during the period of the lease. It’s also important to realise that the Option to Tax legislation is the subject of complex anti-avoidance rules and some tenants may be able to disapply to the option depending on their intended use of the property. 

As ever, there are a number of VAT, tax, accounting, and commercial issues that must be carefully considered before making any decision as regards a change in the original intention of a development.

RSM’s VAT, and real estate and construction teams are very experienced in matters such as these and in helping developers adapt their business model in these challenging times. For more information, please contact

James Burberry Jim Burberry

Partner

Philip Munn Philip Munn

Partner