Andrew Needham looks at the importance of clarifying the contractual arrangements so that the VAT position is correctly identified.
Many contracts do not mention VAT and some just have a short clause saying prices are exclusive of VAT. But how do these types of clauses protect the vendor if there is a query over the VAT liability of the supply, or HMRC rule that the wrong liability has been applied to the transaction at a later date?
How does this affect the vendor?
It is the responsibility of the supplier to account to HMRC for any VAT due. In a property transaction, the property can either be sold or leased. VAT is not always due; sometimes it depends on whether the property is less than three years old and in other cases the issue is whether or not the seller or landlord has chosen to charge VAT by opting to tax.
If a contract is silent about VAT on the price or rent, the normal rule is that the price or rent is inclusive of any VAT that is chargeable (unless there is a change in the law between the time when the contract was concluded and the date when the transaction envisaged by the contract completes). So, if the price was £100,000 and the contract said nothing about VAT, £100,000 would be all that the buyer would have to pay - but, if VAT was later ruled to be chargeable, the seller would have to account for VAT of £16,666 out of the sale proceeds and pay it to HMRC.
If a contract expressly states that the price is exclusive of VAT, with an obligation on the buyer to pay any VAT chargeable, then if VAT was chargeable the buyer would have to pay £120,000, the seller would keep £100,000 and pay £20,000 to HMRC.
There are many cases where a contract remains silent on VAT and HMRC later undertake an inspection and rule that VAT has not been accounted for correctly. This commonly happens in property transactions where the vendor opted to tax many years ago and then forgets that they have opted when they come to sell it or where transactions have wrongly been treated as transfers of a going concern.
Does the contract have to be watertight?
In a Court of Appeal (CoA) case in 2015 (CPL Holding Company Limited v Singh & Anor [2014] EWCA Civ 1103), even though the contract covered the following:
- all sums payable under the contract are exclusive of VAT;
- any obligation to pay money includes an obligation to pay any VAT chargeable; and
- completion of the sale does not cancel any liability to perform any outstanding obligation under the contract.
The CoA decided that, in view of the particular circumstances of the case, the proper interpretation of the contract (looking at what a reasonable person would have understood the parties to have meant) was that the price was inclusive of VAT.
Regardless of whether any element of the court's decision in this case was open to question, the case does highlight the importance of clarity in contracts. The clearer the expression of the intention of the parties, the less likely it is that the courts will become involved.
For VAT, a prudent seller or landlord would not rely on ‘exclusive of VAT’ wording but would state that any VAT chargeable is to be payable by the buyer or tenant in addition to, and at the same time as, the price or rent.
Practical Tip:
If you are drafting a contract, make sure you have clear VAT clauses to avoid an unexpected bill!
