VAT on Tenants' Property Transactions

Understanding VAT on Lease-Related Charges and Property Costs: Essential Insights for Retail Tenants

In this episode, we delve into the complexities of VAT (Value Added Tax) on property leases. We examine the current VAT rates in the UK and the Republic of Ireland, and discuss which goods and services are subject to VAT. We look at the implications for landlords, especially those who opt to charge VAT, and explain how they can recover VAT on their expenses. We also explore the significant impact on tenants, particularly small businesses and charities who cannot offset VAT payments. In addition, we cover the importance of proper documentation, the role of 'applications for payment,' and common pitfalls in VAT invoicing and receipts. This episode is essential viewing for anyone involved in commercial property leasing, providing a comprehensive guide to navigating VAT obligations and avoiding costly mistakes.

00:00 Introduction to VAT
00:46 VAT on Leased Property
01:48 Option to Tax: A Landlord's Perspective
02:34 Impact on Tenants
03:24 VAT Documentation and Compliance
08:49 Applications for Payment vs. Invoices
12:19 Common Mistakes and Risks
16:54 Conclusion and Advice

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Transcript

0:00

Welcome to that Retail Property guy with your host, Gary Marshall. In each podcast episode, we delve into topics from the perspective of a retailer as tenant sharing stories and insights through Gary's unique lens. We hope you'll be entertained, enlightened, and may be a little inspired. In this episode, let's discuss VAT value added tax. Currently in the UK it's 20% on most goods and services. In the Republic of Ireland, it's currently 23%, but not all goods and not all services are subject to VAT. And not all businesses, especially smaller retailers, have to charge VAT charging. VAT can make a big difference to the end cost for the customer. In leased property, some rents and other costs are subject to VAT. Some are not. A lot of this depends on the landlord's VAT position, so let's start there. In the uk, the default position from HMRC standpoint is that sales or rents of commercial property are exempt from VAT. That might sound good. No need for the landlord to charge VAT. But it also means that the landlord can't recover VAT on their expenditure, whether that's professional support from managing agents, legal fees from landlords, renovations, or other repairs, which might be the landlord's obligation. So a landlord could end up shelling out 20% vat on all their costs, but not be able to pass that 20% on or offset it anywhere. So it increases their outgoings. Hmm. That's bad for landlords. Not all landlords. Of course. There are various circumstances where some landlords might still prefer to not charge VAT. More on this later. But for those landlords who find the payment of VAT is a burden that they could do without, there is a way to make it someone else's burden. This is known as the option to tax or electing to charge VAT. By electing or opting, a landlord of commercial property can recover VAT on costs associated with that property. This option isn't something for a landlord to take lightly. Once opted in, it's binding for 20 years. It means dealing with HMRC on strict deadlines, effectively becoming a tax collector with no pay, but a big risk of penalties. But the cost benefit seems clear. So many landlords who are eligible to opt for tax, IE to charge VAT will do so at the first opportunity. Adding VAT to charges increases the cost to the tenant unless they too are VAT registered and can offset the VAT they pay to the landlord against the VAT they collect from their customers. And bear in mind, not all tenants can offset VAT. Many small businesses are not VAT registered, and other tenants like charities might have a different exempt VAT status. So in both those cases, the tenant would have to absorb the VAT like a rent increase, and for landlords who do opt to tax. To charge VAT. Their admin process also changes. They now act as an unpaid agent of the VAT man, HMRC, and they have to produce all the paperwork to support this. This paperwork carries responsibility and risk for both the tenant and the landlord. The first and most obvious big change is that the landlord must now produce paperwork for the rent and so on. Most people outside the property business, and to be honest, quite a few within it believe that that's nothing new, that landlords must always invoice for rent. But it's not entirely true. If a landlord isn't within the VAT regime, hasn't opted, isn't charging VAT, then maybe they don't have to produce any invoice at all. This concept spooks quite a few accountants and auditors for these non VAT landlords. The lease is the contract to pay, no need to issue invoices. Tenants who read their leases might often see a phrase to pay the rent, whether formally demanded or not. This means they have to pay even if they don't receive an invoice. Then if the landlord opts to charge VAT on top of the rent, they're still not legally obligated to issue a formal VAT invoice, but they are legally obligated to provide a VAT receipt. This bit probably isn't written into the lease, but it is a legal tax obligation on the landlord. Any customer who pays VAT. On any charge for anything is entitled to a VAT receipt. They can then use this to demonstrate that they have paid VAT, and if they themselves are VAT registered, they can then seek to offset that outgoing VAT against any incoming VAT that they've charged to their customers. The VAT gets passed on. The net effect of the business in the middle can be as low as zero, but this offsetting is very complex. A tenant who is VAT registered so charges VAT on their goods and services, has also become an unpaid tax collector and has to produce and archive lots of documentation as proof of the tax. The VAT coming in and out. This process is known as input output, and it's important to get the labels right to understand which handle applies because the labels are a bit contrary. Input VAT is what a business pays out on its purchases while output VAT is what a business charges to its customers on its sales and services. That's right. Input means outgoing. While output means incoming bonkers, eh, but okay, let's summarize the story. So far. A small independent landlord with taxable turnover below 90,000 pounds a year. These are 20, 25 thresholds. Doesn't need to opt to tax. So it doesn't have to charge VAT and doesn't have to issue invoices or receipts. If they feel that the VA they pay out, aggregates up to a big sum that they find hard to absorb, they can voluntarily opt bigger Landlords with a higher annual turnover have to register for VAT in general, but can still choose whether to opt for VAT on any specific property. If they don't opt, they can't offset the input and output VAT. If they do opt, they can offset. Simple so far. Once they opt, they're bound for 20 years and have to start issuing VAT receipts. They might choose to issue VAT invoices, but the obligation is on the receipt. And tenants who are not VAT registered or are exempt like charities can't offset the VAT. They get charged. For them, it's an additional cost hitting their bottom line. So now let's consider a landlord who has opted and the impact on the tenant of that property. What happens now? Well, the landlord can now start offsetting the vat. They pay from the vat. They charge VAT input output offset. If they charge more VAT than they've paid out for anything. The net effect is pretty much zero VA paid by the landlord. This is a big cash flow win for them. Overall costs come down. Their bottom line looks better. They have successfully passed the VAT obligation downstream to their tenants. So now the tenant has to start paying plus VAT. The lease might state the renters, I dunno, a hundred thousand pounds per annum, payable, quarterly, but the tenant now has to pay. 30,000 pounds, not 25,000 pounds per quarter. The extra is VAT. They're entitled to a receipt and like the landlord, if they charge more on their goods and services than the va, they've just paid out. The net effect to them is pretty much zero. They too have passed the VAT charge downstream to their customer. Somebody will always be at the end of this line, unable to offset any vat, just having to bear that tax burden. It's often a personal customer or a small business who isn't VAT registered and can't offset anything. These little guys pick up the VAT tab for all the links in the chain before them. Now we mentioned the documentation. It's not just a bit of paper. Even for the small guy at the end of the chain, it can sometimes be a proof of payment for expenses, something that their employer will reimburse. No receipt, no expenses. So hang on to that lunch receipt, that fuel receipt, that hotel bill. What about the train ticket? Ah, in the UK, VAT on rail and coach travel is 0%. Your receipt should show that, so no VAT to offset, but you can still claim the basic non VAT cost. This just demonstrates that the receipt is important. The same goes for businesses. Keep the receipts or the VAT invoice or both, but tenants should be wary of the bit in between the gray document. That's neither VAT invoice or VAT receipt. Technically not worth the paper it's printed on or the PDF. It was created as, what am I talking about? Well, some landlords make a halfway gesture. They recognize that the lease defines that they don't have a legal or tax obligation to provide a VAT invoice, though they do have to provide a receipt, but they also recognize that many tenants need something to process in order to arrange payment. Notwithstanding that the lease probably says pay weather formally demanded or not, they might still choose to issue a kind of halfway house document that isn't a formal demand. It's more like a reminder. These shadowy documents are known as applications for payment. They serve as nudges and reminders ahead of the due date. The tenant now has no excuse to not be ready to pay the rent, right? The application for payment probably states the gross sum, which is expected. That's the total charge, including the VAT, but it will also state somewhere often buried in the small print that the document isn't an invoice. There's a strong reason for this, a clever trick running in the background because these are stated not to be invoices. They don't crystallize the VAT, sorry. Well, okay. An application for payment often looks like an invoice. To all intents and purposes. It pretends to be an invoice, but it lacks one key item, a tax point. This is a date or a timestamp at which an invoice is formally raised. Now remember that opting to charge VAT makes the landlord an unpaid tax collector for HMRC. That is, after all, just tax collection by proxy, hundreds of landlords and other businesses all collecting taxes on behalf of HMRC without getting paid for the privilege. The landlord has obligations to HMRC, the Batman, which are very tightly managed. They have deadlines, due dates for payments, obligations to pass over any VAT, which they haven't offset. All those bags of gold on the sheriff's table by the deadline or else, and that deadline starts running from the date or timestamp on the invoice. If a formal invoice includes VAT, its date of issue specifies and triggers the VAT quarter within which the landlord has to pass the collected VAT onwards to HLRC. If a landlord raises a document, calls it an invoice, and puts a tax point date stamp on it, the clock starts ticking. It crystallizes their obligation to pass on the vat whether or not they themselves have received those funds from the tenant. You can see their risk, the exposure to a nightmare of negative cash flow, maybe having to pay funds to HMRC that haven't yet come in from a tenant. So the clever application for payment gets round that crystallization the landlord asks for the rent with the VAT on top, but without actually raising a formal invoice once the funds come in from the tenant. They can issue a formal VAT receipt, which does show the tax point being the date the funds arrived, and that starts the clock ticking, but with much lower risk for the landlord because they now already have the VAT funds in their hands ready to pass on. Applications for payments are not invoices. They might look like invoices. They might act like invoices. But if they say they aren't an invoice, then they aren't an invoice, and naturally tenants should bear in mind that not all applications for payment or even invoices come to that are correct. Landlords and their managing agents are well known for billing errors, whether accidental or otherwise. So the tenants accounts team should be wary, check the fine details, double check against expectations. Check that they have seen a copy of the option to tax. Don't just pay VAT because it appears on a demand without first validating that the landlord, not the agent has opted. I've witnessed examples of landlords unlawfully demanding VAT and of tenants paying it and offsetting it in their own accounts based on a simple misunderstanding and naive expectation that that was correctly due. Not paying VAT when you should do gets you in trouble with the Batman, paying it when you shouldn't. Well, that's your own debt to recover. Oh, and speaking of VAT payment mistakes, tenants accounts, teams should be extremely alert to VAT receipts. They so often look just like invoices. It can be difficult to discern them from an actual invoice, but they might have a slightly different reference number and maybe the word receipt stamped on it in big red letters. The vigilant accounts team will notice this and won't process payments a second time. Or will they? I've witnessed numerous situations where payments have been duplicated based on both the early application and the final receipt. It's an easy slipup, but an obvious one to guard against, and even VAT receipts themselves are not always factually correct. Once again, managing agents billing errors, the bane of an accounts team's workload, that receipts are often autogenerated when a landlord's cashier processes a transaction, usually this transaction is the correct allocation of a sum received from a tenant allocated to the right lease, the right property, the right charge, eg. Rent, not service charge, or vice versa. For the correct occupational period, the June quarter, not the March quarter, but frequently I see examples where a cashier either misallocated an incoming amount posting it to the wrong lease or to service charge instead of rent, or did some internal juggling of their own invention to clear up some open items in their ledger, which involves reposting earlier transactions, which don't actually represent anything that the tenants intended. The cashier or their automated system then sends a VAT receipt saying, thanks. We've allocated your million pound service charge to catch up. And the tenant thinks, well, that's great, but we haven't paid anything like that. So what on earth have they done? The erroneous VAT receipt has two big consequences. It can indicate to a tenant that the landlord's cashier has made a big mistake, which must be chased down and rectified as a matter of urgency before it becomes accepted as fact. But it also appears as a variance for the tenant's own VAT records seeming to be a payment they never made and which they might never offset. In short, the VAT world falls off its axis when landlords, cashiers make allocation mistakes, and the risk of penalties from HMRC doesn't always fall directly to the cashier. The first stop might be a claim against the tenant. So the final word in our discussion on VAT on property lease costs from a tenant's perspective is to always check VAT documentation, be certain it's correct, and archive it well. I repeat archive it well, six years worth to be easily tracked and pulled out for inspection by the nice people at HMRC. The risk here is immense. We're not talking about a slap on the wrist or some token interest charge or a black mark. In extreme cases, HMRC could decide that a tenant's entire VAT records are not robust to the extent of doubtful or untrustworthy, and they could reverse all the input output offsets that the business has made. This would mean the business repaying to HMRC, all the VAT that they had claimed as offset going back years. Consider that VAT is 20% of the actual charge, then this backdated VA penalty could be huge. For bigger businesses, it could run into millions. All tenants who pay VAT should archive their invoices and receipts in case they get a control from the Batman, and they should have already checked that they were correct, right? Duly opted. Aligning with expectations, aligning with payments actually made not mistakenly allocated internally by a landlord's cashier, be that human or robot. If you feel you need any advice on any aspect of VAT on your lease charges, reach out to a professional with suitable and relevant experience in this sector. Don't leave it to chance. The value of good advice can far outweigh the cost of it. Thank you for listening to that Retail Property guy. I hope you enjoyed today's discussion and found it both entertaining and insightful. Don't forget to explore more episodes. If you enjoyed the show, please consider leaving a review. Your feedback is greatly appreciated. Thanks again for tuning in.