Making a full recovery

Ordinarily, the sale of land is exempt from VAT under the 1994 VAT Act. But in 1989 the "option to tax" was introduced. It gives the seller the chance to waive that exemption – effectively, to choose that VAT be charged on the sale.

Where land has been purchased with VAT and sold without, the VAT incurred on its purchase will not be recoverable.

And from the seller's perspective, even if VAT was not incurred on the purchase of the land, it will be incurred on professional fees relating to the transaction, so it is in the interest of the vendor to ensure that they are fully taxable wherever possible.

Often, vendors have a blanket policy to opt to tax all their land. The result, therefore, is that RSLs can expect to be charged VAT on land more and more often.

RSLs and VAT
As you will be aware, the recovery of VAT on the purchase of goods and services depends on them being used to make "taxable supplies" – the provision of services or sale of goods on which tax can be charged.

So an RSL must make taxable supplies in order to be able to recover VAT on its purchases. In the case of land, the "supplies" the RSL is making are usually general-needs developments that are let on short-term, assured tenancies. These are exempt from VAT, however, so VAT recovery is not allowed.

"Aha!" I hear you say. "We are an RSL, so we don't pay VAT on land."

Well, to some extent this is true. Under the VAT Act, where land is to be used by an RSL for the construction of homes or relevant residential buildings (a care home, for example) the option to tax can be "disapplied". This means the buyer refuses to pay the tax that the seller has chosen to opt into. It is done by way of certificate to the seller: if a certificate is issued disapplying the option to tax, the purchaser pays no VAT.

This is a very effective piece of legislation but where the vendor has purchased the land with VAT, that VAT will not recoverable by him or her. VAT therefore becomes a cost to the vendor that they are unlikely to be prepared to bear if the RSL tries to disapply the option to tax. At this point, my experience is that the vendor either walks away, wants to charge VAT, or expects the cost to them to be reimbursed to complete the deal.

It may be that they haven't paid VAT on the land and perhaps don't really understand the position – maybe they are under the impression that they have to charge VAT on the land to recover VAT incurred on costs.

Ordinarily, the sale of land is exempt from VAT, but the ‘option to tax’ means the seller can waive the exemption

It is true that the VAT on these fees cannot be recovered, but this VAT will be tiny compared to charging VAT on the land. This can be a negotiation point and an RSL could offer to pay the VAT incurred on costs if it will help to seal the deal.

How to get round VAT if you incur it
The most well-known and widely used method is the "golden brick" scheme. Effectively this uses the legislation relating to new-build dwellings to "wash away" the VAT.

The first grant of a major interest in a dwelling by the person constructing – the sale of the freehold or the grant of a long leasehold, for instance – is subject to VAT, but at a rate of zero. This means the VAT incurred in making it is recoverable.

Included within the definition of a dwelling is a partly completed dwelling or its site, so a dwelling "in the course of construction" may also be zero-rated. There is no strict definition of what constitutes a dwelling "in the course of construction" but it has been widely accepted that this is one course of bricks above the foundation or damp proof course – the "golden-brick level".

To successfully use the golden brick scheme the vendor develops the plot to golden brick level and transfers the land to the RSL. This is a zero-rated supply, so the vendor can recover the VAT incurred. The value of the supply is the value of the land plus the cost of the building works undertaken at that point.

Thereafter, the vendor continues the development of the site under contract to the RSL which is a zero-rated supply of construction services. The purchasing RSL is also deemed to be the "person constructing" and therefore can zero-rate the first grant of a major interest if necessary.

There are variations on this method where sometimes the vendor is not willing to or doesn't act as developer. In these cases it's possible for the RSL to buy the land with VAT, opt to tax it and sell it onwards, with VAT, to a third-party developer. The third party builds to golden-brick level and then sells back to the RSL and continues to develop.

This mitigates the VAT but is rather circuitous and has the potential to be challenged by Customs & Excise; it may also incur additional costs such as stamp duty land tax on the transfer to the developer. This will reduce the savings.

Commercial units
Developments that have commercial units are becoming more popular, with sites developed with shops or offices on the ground floor and flats above. In this case the golden-brick stage only occurs once the commercial units have been built, so any transfer must take this on board.

The freehold sale of a new commercial building will automatically be standard-rated for VAT and as such the RSL must opt to tax the site to be able to recover the VAT on the commercial building.