What is the Option to Tax?
The option to tax allows a business to choose to charge VAT on the sale or rental of commercial property i.e. to make a taxable supply out of what otherwise would be an exempt supply. Any option to tax does not affect a residential building or residential part of a building.
Why Would You Want to Opt to Tax?
The key to this is the ability to recover VAT on related costs. What you are doing is turning an exempt supply – on which you can’t recover any VAT – into a taxable supply on which can recover any associated VAT.
Most businesses do not need to opt to tax their trading premises – they are using them for making taxable supplies in their normal business. You only need to consider opting to tax if renting property or selling your trading premises in certain circumstances.
Examples of When to Opt to Tax
You buy a new commercial property for £650,000 with the intention of renting it out. Because it is a new commercial property you are automatically charged VAT on the purchase price - £130,000. If you simply rent it out without doing anything you will not be able to claim this VAT back because of the exempt rental income.
However, if you decide to opt to tax the property you would have to charge VAT on the rents to the tenant. In return you could reclaim all the VAT on the purchase, the associated professional costs and any ongoing expenses. If you decided to sell the property you would have to charge VAT on the sale.
In our next example, a manufacturing business buys premises for £500,000 in 2008 plus VAT of £87,500. He reclaims this in full as the input tax is attributable to his fully taxable manufacturing business.
After 5 years his business is doing so well he decides to sell up and move into bigger premises. Unfortunately for him the building is covered by something called the Capital Goods Scheme (CGS), which covers commercial building over £250,000 and lasts for 10 years. If he changes the use of the building from taxable to exempt within 10 years he will need to adjust the amount of VAT reclaimed.
If he sells after 5 years the remaining 5 years of the CGS adjustment period will be viewed as all exempt use and the VATman will ask for half the VAT back on the original purchase price (£43,750) – a rather nasty surprise!
If he opts to tax the property before he sells it (even the day before) then he will charge VAT on its sale, it will be a taxable supply rather than exempt, and he won’t have to pay back any of the VAT that he originally claimed.
Opting to tax is quite easy: you complete form VAT 1614A (there are other forms in the series but this is the main one you need to worry about) and send it to HMRC. You can opt to tax one property at a time or all of the properties you own – it’s your choice.
By Andrew Needham