Clarified guidance from HMRC on VAT treatment of overage

Please note that this article only considers VAT issues in relation to overage payments – there are other tax issues which also need to be considered, which are beyond the scope of this article.

Key Takeaways

• For housebuilders, overage can materially affect deal costs long after completion. HMRC’s clarification means VAT on overage is not fixed at purchase and must be reassessed when the overage is triggered.
• That creates both risk and opportunity: overage that was assumed to be VAT‑bearing may ultimately be zero‑rated or outside the scope, but the reverse can also apply.
• Buyers should therefore factor VAT outcomes into overage drafting, pricing assumptions and financial modelling, and keep the VAT status of the land under review throughout the development lifecycle.
• Overage on the freehold sale of a new commercial building remains standard‑rated, even if the overage is paid years later and the building is no longer “new”.
• SDLT is payable on any VAT charged on consideration (including overage), so VAT being chargeable can increase the buyer’s SDLT cost.

What is overage?

Overage is a payment made by a buyer to a seller after the seller has sold its property. It is a way of giving the seller a share in future profits or uplift in value, and is generally payable only if certain pre-agreed “trigger events” occur. For example, an overage payment might become due if a planning permission is granted within a certain timeframe, or if the land is sold on again later at a profit. In residential development, overage will often become payable if sales receipts exceed a certain level.

VAT in land transactions

The starting point in land transactions is that a sale of land is exempt from VAT (with a few exceptions).

However, a landowner can choose to exercise an option to tax in relation to their land. Once that option has been validly made, any subsequent sale of that land will be subject to VAT (unless the option to tax has been disapplied (or ‘switched off’) in the meantime, which can happen in a variety of circumstances – most of which are beyond the scope of this article).

VAT and overage

The complicating factor with VAT and overage is that, although the overage payment is linked to the original sale, it generally won’t be paid until much later – by which time the VAT status of the land may have changed. The question has therefore always been: do you charge VAT (or not) based on the VAT status of the land when the sale completed, or do you look at the position when the overage falls due?

HMRC’s approach on this has been inconsistent in the past, but they have recently clarified their position.

HMRC have confirmed that, in general, the VAT treatment of an overage payment will be determined by the VAT status of the land at the date when the overage falls due.

The rationale for this is that there is no way of knowing at completion how much the overage will be. Depending on how matters turn out, it could potentially be zero. The payment of overage is therefore treated as a separate supply of land for VAT purposes, and the VAT position needs to be considered once the overage amount crystallises and falls due.

Any party receiving or making an overage payment therefore needs to be aware that this payment will not necessarily be subject to the same VAT treatment as the payments made pursuant to the original transaction.

One example of this is where a landowner exercises a valid option to tax in relation to their land and then sells that land to a residential developer. At completion, the developer will pay VAT on the land price in the usual way, because an option to tax has been exercised. However, once the residential development is underway, the effect of building dwellings on the land will impact the seller’s option to tax and whether or not VAT is chargeable – meaning that future overage payments might not be subject to VAT at the standard rate and may in some circumstances be zero-rated.

The exception – freehold sale of new commercial building

For those developing and investing in commercial real estate, there is one important exception to all of this.

The freehold sale of a new commercial building (meaning a building which is less than three years old and not designed as a dwelling or for a relevant residential or charitable purpose) is always standard-rated, meaning that VAT is always payable on the sales proceeds. This rule continues to apply to any overage payments falling due on this type of building – even if by the time that overage becomes payable the building is no longer “new”.

If a new (or incomplete) commercial building is sold subject to an overage, VAT will be payable on that overage, even if it falls due many years later when the building is no longer “new”, and irrespective of whether or not an option to tax has been exercised in the meantime.

And finally…

It’s worth remembering that, whatever the circumstances, the buyer always pays Stamp Duty Land Tax on the VAT element of any consideration paid – whether that is overage, or the original sale price.

Buying land which is standard-rated for VAT, whether because an option to tax has been exercised, or because it is a new commercial building, will therefore always mean the buyer pays more SDLT (unless something happens to disapply the option to tax).

The difference between overage and deferred payments

It is the uncertain nature of overage payments which gives rise to this special VAT treatment.

Where a purchase price is fixed at the outset, but payable in instalments:

• The VAT treatment of all instalments will be the same, and will be based on the VAT status of the land as at completion of the sale.
• VAT on the whole purchase price will be payable upfront on the date of completion of the sale.

This article is for general information purposes only and does not constitute legal advice or a comprehensive statement of the law. Specific legal advice should always be sought in relation to individual circumstances.

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   • Rachel Walbourn

   • Partner
   • Housebuilders & Residential Development

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   • Liam Floodgate

   • Partner
   • Housebuilders & Residential Development

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   • Harriet Forster

   • Partner
   • Housebuilders & Residential Development

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