VAT treatment on land transactions: what to look out for this year

While an early termination fee for a mobile phone operator should be set out in the contract, a dilapidations payment is an amount for damages that is agreed outside of a lease agreement. In its latest draft, HMRC accepts this contractual difference, as well as the practical challenges of calculating a notional amount that reflects normal wear and tear out of a total settlement.

On Monday (7 February 2022) HMRC confirmed that dilapidations would normally not be part of the consideration for renting the property, so payments are not subject to VAT.

With the significant changes to the way we live and work over the past couple of years, many housing associations have agreed to terminate the leases of their commercial tenants. Some are also looking to terminate their own office leases. It is helpful to have confirmation that any payments agreed for dilapidations are not subject to VAT.

HMRC’s updated policy is effective from 1 April 2022, but any landlord that has been charged VAT on a dilapidations payment in the interim is entitled to correct that.

It should be noted that dilapidations payments are seen as different from the ‘void charges’ that are sometimes issued to a departing residential tenant who has damaged their dwelling beyond normal wear and tear. There is no indication to date that HMRC has changed its policy that these are subject to VAT, in line with other recharges to tenants for doing repair work that is their responsibility.

Overage payments

Part of the commercial negotiation with many landowners will be some form of overage payment, where an additional payment becomes due to the seller if certain conditions are met.

Examples include a payment if a revised scheme is agreed with planners with additional units, or a percentage of sales proceeds achieved above a certain level. These might be payments due from the association to the seller, or the association itself might be the seller, selling some land for open market sales to a commercial developer.

For VAT, this raises the question of what this payment is for. Generally, it is regarded as a further payment for the sale of the land. But the VAT treatment of land can change over the life of a project.

The sale of a bare building plot would be subject to 20 per cent VAT if the owner has opted to tax. Once it has houses or flats built on it, the option to tax would no longer have effect and no VAT would be due. If you bought the plot before it was developed, but are now paying an additional amount for it after it has been developed for housing, is this subject to VAT?

The conclusion to this question remains unclear, although an argument can be made that the VAT treatment is based on the status of the land at each point a payment is made. Whatever the outcome, it is expected that this will be clarified in a few months’ time.

Call options

An overage payment may make sense where it is certain, or at least expected, that suitable planning permission will be obtained.

For more speculative sites, housing associations and other developers may seek to hedge their position with a call option. The prospective developer would pay an amount to the landowner for the exclusive right to purchase their property within a set time frame for a certain price.

During this period, the developer will seek planning permission, and if unsuccessful can walk away from the deal without being burdened with a property it cannot develop.

It had been understood that these payments were treated in the same way as payment to actually acquire the land itself. HMRC took a test case to challenge this treatment, but the tribunal agreed that these should be treated as payments for an interest in land. HMRC has not appealed this decision.

It is understood that its updated guidance will not seek to change the general policy but will deal with some more nuanced concerns. It is hoped that this guidance will be published by the autumn.

Rights to light

The final area being looked at is rights to light. A new building may reduce the daylight that is enjoyed by the property next door. A payment may be made by the developer to compensate the neighbour.

Is this compensation payment to be treated as damages (like dilapidations) and not consideration for VAT purposes? Or is it a payment for some form of interest in land? Or for something else? If it is for land, is it subject to VAT if the neighbour has opted to tax? And do they opt to tax their land, which is affected by the shadow of the new building, or your land, on which the new building sits? 

With so many questions, it is perhaps not surprising that views of HMRC and advisors have been inconsistent over the years, and this issue seems to be last in the queue to deal with. However, these payments can be quite substantial, so it is hoped that by this time next year we will have confirmation on these points.

While housing associations may not always agree with the position HMRC takes on these complex land transactions, it is certainly preferable to have a clear understanding of what the official position of HMRC is. Housing associations are ramping up their development programmes to regain some of the momentum lost over the past few years, and these clarifications should enable them to budget with more certainty.

Adam Cutler, lead – social housing tax, Crowe