What Does an ’Option to Tax’ Cover?

What Does an ’Option to Tax’ Cover?
Why opt to tax?

The normal position is that the rental of property is exempt from VAT, as is the freehold sale of commercial property over three years old.  Because these are exempt supplies, businesses can’t recover any VAT that they are charged in relation to these supplies.  

In order to recover VAT on the construction or refurbishment of commercial property, HMRC allows businesses to ‘elect to waive exemption’ or what is more commonly known as ‘opting to tax’ by completing a VAT1614A and sending it to HMRC.  The freehold sale of new commercial property under three years old is automatically standard rated, not just the first sale – any sales providing the building is under three years old.   

Once you have opted to tax you have to charge VAT on the rent, lease or freehold sale of the property but can recover the VAT on any associated costs – sounds simple, but in reality the rules are highly complex and cause great confusion.

Common misapprehensions

One of the most common misapprehensions is that when a business opts to tax a property it’s the property that’s opted and the option carries over to a new owner if it’s sold.  But this is not the case; a business opts to tax its interest in a property so if it is sold the new owner has to decide if he wants to opt to tax and then he has to notify HMRC of his option.  The same applies if a tenant of an opted property sub-lets it.  The tenant has to decide if he wants to opt to tax the sub-lease and if he does he has to notify HMRC.

Another common misapprehension is that the option to tax also affects residential properties.  For example, where you have a mixed development with shops on the ground floor and flats above, the option only affects the commercial element so the rental of the flats remains exempt and if the property is sold the purchase price has to be apportioned between the VATable commercial element and the non-VATable residential part.  In the case of pubs with a manager’s flat above, HMRC have agreed a 90% - 10% apportionment for the ratio of taxable and exempt.

Disapplying the option to tax

There are a number of circumstances when an option to tax can be disapplied.  These are:

when a purchaser wants to buy a commercial property and convert it into residential use; for example, a barn conversion or converting an office building into residential use; he can issue the vendor with a form VAT 1614D;

if a housing association buys either land or buildings with the intention of building residential property, it can issue the vendor with a form VAT 1614G to disapply the option; and

there are certain anti-avoidance provisions where two connected parties rent property to each other and one cannot recover its VAT where the option is disapplied – it’s more complex than that, but it would take a small book to explain it!

The problem when an option is disapplied is that the vendor may have a clawback of VAT already claimed if the property comes within the capital goods scheme.

Time limits

When a business opts to tax a property it can change its mind and withdraw the option within 6 months of making it, providing it hasn’t claimed back any VAT or made any supplies of the property.  A business can also withdraw its option once 20 years have elapsed.

Practical Tip :

The option to tax has to be renewed whenever a building is sold or sub-let. It does not apply to residential property, and there are certain circumstances when it can be ‘disapplied’.

Andrew Needham