SDLT and VAT in property transactions
Read a guide from our tax expert, Haydn Rogan, on stamp duty land tax and VAT in property transactions.
Stamp Duty Land Tax
SDLT is a tax that arises on transactions involving the sale and purchase of land and the creations of interests in it such as a lease.
The HM Revenue & Customs website provides information on rates and thresholds. Although HMRC have not always kept it up to date, it does contain relevant information about tax thresholds and also a ready reckoner to help calculate duty on straight forward transactions.
When considering the tables, it should be noted that the rates are not marginal. The tax rate shown is the tax rate on the value of the whole transaction. For example, the current (Autumn 2009) threshold for payment of duty is £175,000 which means that a purchase of residential property at a price of £170,000 would attract no SDLT, but the purchase of a house for £180,000 attracts duty at 1% of the total price amounting to £1,800.
There are a number of exemptions to SDLT. One exemption applies to registered social landlords who can avoid SDLT if certain criteria are satisfied. If the exemption applies to them, it can be advantageous to developers entering into agreements with housing associations to acquire and develop land jointly, as the SDLT exemption may be available to both parties provided the legal contract is structured in such a way that the developer rides “piggy-back” on the RSL in relation to the initial land acquisition contract.
It is necessary however to ensure that subsequent transactions relating to the development of the land are not treated as linked for SDLT purposes. The issue of linked transactions is very important in the context of SDLT generally.
If transactions are linked (that is, they form part of one larger agreement between the same parties) then the aggregate value of the transactions is used to calculate the duty payable. For example, the investor who buys three flats for £120,000 each under the same contract will be treated for SDLT purposes as having acquired land under one transaction worth £360,000 and will therefore pay duty of £10,800.
If the same investor purchases the same three flats under three separate contracts and there is no commercial linkage between those contracts (such as a volume-purchase discount) then there are three separately enforceable contracts at values below the SDLT threshold and no duty is payable on either of them.
It should be made clear that purchasing three flats under separate contracts will not always avoid the linked transactions rule. If the contracts have the same seller and the same buyer, HMRC may presume they are linked and it will be for the buyer to prove otherwise.
To avoid the possibility of multiple purchases being treated as linked transactions, an investor might set up three separate companies to acquire each of the three investment flats.
Even though the companies might be linked by common ownership, they are separate entities in law and transactions can only be considered linked where they are made between the same parties.
Questions of linkage also arise under development contracts. For instance, if a developer part-builds a house and then sells the land to a buyer for £150,000 no duty is payable provided the buyer later instructs another builder to complete the works. However, if when the buyer acquires the land he also enters into a contract with the builder to complete the works for an additional consideration of, say, £50,000, then the transactions will be considered linked and the buyer will pay duty based on a total transaction value of £200,000.
On the other hand, however, where a buyer buys the land from a developer for £50,000 but then, under a separate contract, awards to the developer a contract to build a new house on the land for £150,000 then as long as the two transactions are not linked (for instance, a developer sells land to the Buyer worth £100,000 for £50,000 on condition that the buyer gives the developer the building contract) the transactions are not considered linked for SDLT purposes and the buyer pays no duty.
The same principle can be applied to development opportunities. In a recent case a large local authority wished to acquire a new headquarters building. There were two separate components to the contract: the land acquisition and the design and build of the new building. The combined cost of the two contracts was around £40 million. However, by structuring the deal so that the land was acquired first for £5 million, and the design & build contract awarded to the original land owner for £35 million the buyer was able to make a significant stamp duty saving. In this example, the buyer saved £1.4 million of duty.
The essential point is that the land acquisition contract and the design and build contract should form two separate contracts, whether or not the latter is awarded to the original land owner.
The leading case from 1992, and still considered good law, is Prudential Assurance Company Limited v Inland Revenue Commissioners where HMRC tried to assess duty on the total transaction price of £10.7m being the actual land price of £6.1m together with the cost of constructing a finished building. The tax payer’s appeal was allowed and duty was assessed on the land price only of £6.1m because the contract for the acquisition of the land and the contract for the design and build of the new house on the land had bee separated.
No-one concerned with the ownership, development, financing or management of property can afford to ignore VAT. The recent 15% rate “holiday” is soon to be over and will shortly rise back up to the previous 17.5% level.
The first thing a prudent purchaser of land will ask of a seller is whether there has been an election to waive the exemption to VAT in respect of the property. Such an election can be made by notification to HMRC by a VAT registered person or company being the owner of the land.
The effect of an election, in simple terms, is to turn a contract for the sale of land into a taxable supply for VAT purposes. Where an election has been made, the seller will charge VAT at the standard rate, unless the property happens to be residential in character in which case the charge to tax is at the zero rate.
If the property is commercial in nature, the buyer in order to reclaim the input tax will have to be registered for VAT. This can have an adverse cashflow implication for a buyer as the VAT payable on the purchase price will have to be paid to the seller on completion (and the seller will account to HMRC for it) whereas the buyer will only be able to reclaim that tax at the end of its current VAT quarter, which may be a couple of months later.
It is worth noting that Stamp Duty Land Tax is payable on the VAT inclusive transaction figure.
For instance, if a VAT registered land owner makes an election to tax in respect of a development site and then sells that development site for £5m it will (from 1 January 2010) attract VAT of 17.5% or £875,000. If the Buyer is registered for VAT it may be able to recover the VAT input tax, but will pay SDLT on a total transaction value of £5,875,000 ie £35,000.
Despite a number of threats by tax payers to challenge this rule, the position has not been changed by HMRC.
Elections to tax are made by land owners to enable them to recover their own VAT input tax. For instance, in the example above, the seller might have made an election to tax to recover VAT on demolition or site remediation costs.
A recent change to the rules means that an election is no longer a “once and for all” election, and land owners can now reverse an election. However, in this example, it would not be to the land owner’s advantage because the land owner would then have to repay the input tax reclaimed on the demolition and remediation costs.
The VAT rules can work to the detriment of housing associations and other bodies whose principal activities do not involve the making of taxable supplies for VAT purposes. It can be difficult for such organisations to recover VAT input tax on land purchases. So whilst it might be advantageous from a Stamp Duty Land Tax point of view for a registered social landlord to acquire development land (because RSLs often enjoy a Stamp Duty exemption), they may be at a disadvantage when compared with other developers in terms of reclaiming VAT on land purchases.
Finally, there can sometimes be difficulties in ascertaining whether or not there has in fact been an election to tax. When buying “distressed stock” from a liquidator or receiver, the directors of the company in liquidation or receivership will very often not be entirely co-operative about producing all relevant VAT records. There can be a difficulty in getting clear information out of HMRC as to whether or not they have records of an election having been made in respect of a specific property.
The difficulty is compounded where a transaction is done on the basis of a quick deal. In a recent case, there was evidence that there had been an election to tax by a previous land owner because a previous transfer found with the deeds had referred to the price of the land plus VAT on that transaction being paid on completion. However, on enquiry, HMRC were unable to say whether they had received any such election. Eventually after several months of correspondence, HMRC wrote to say “if a legal entity has not opted to tax land or buildings the sale of these land or buildings would not be subject to VAT”. Therefore in the absence of evidence of an express election by the land owning company, now in liquidation, the liquidator and the buyer were entitled to assume that the sale of the land did not constitute a taxable supply for VAT purposes.