Having looked at the administrative process of notifying Option to Tax, there are a few facts about Option to Tax that are worth setting out. People with limited understanding can argue against some of the following points, and thereby increase their own and others’ costs during a transaction.
This tax election is aptly named because it is entirely optional. There is no circumstance where anyone is compelled to notify an Option to Tax and start charging VAT on their property.
There are many situations where it does not make commercial sense to decline notifying Option to Tax and take on the obligation of VAT compliance.
That said, there can be commercial circumstances where it makes sense for someone in a very specific situation to ‘swallow’ an initial VAT cost by deciding not to pursue a VAT option on a particular property, in return for freeing themselves of the obligation and risks related to maintaining VAT records and filing quarterly returns with HMRC.
A commercial value judgement is required and for this reason, bespoke VAT advice is always beneficial when considering any potential property acquisition.
The fact that someone has notified an Option to Tax on a particular property does not automatically mean that anyone else is bound by their tax election. The property itself does not ‘become taxable’ when Option to Tax is notified – the taxpayer making the tax election only binds themselves and their use of the property, not anyone else.
This means, for example, that if a property owner has opted to tax and lets out space in a building, their tenant will have to consider their own VAT position if they then wish to sub-let the space to a different party. The rent paid between the sub-tenant and the head-tenant will remain exempt from VAT unless the head-tenant notifies Option to tax to HMRC.
The only nuance to consider here is where you are a member of a VAT Group – where one member of the group notifying an Option to Tax can bind other group members. For this reason, bespoke VAT advice is usually helpful when there are complicated ownership/occupancy structures present.
If HMRC does not know about someone’s Option to Tax, it is not valid. Failure to notify Option to Tax at the point you make the tax election can mean that you don’t comply with VAT obligations in the correct way; in turn this opens the risk of penalties from HMRC. You can also find that selling the property becomes stalled while the VAT position is clarified.
There is scope to have HMRC accept a belated notification of Option to Tax depending on what evidence you have of making the tax election and how you’ve behaved subsequently. However, this is not guaranteed and can accrue substantial professional fees to argue your case with HMRC.
For this reason, bespoke VAT advice is generally worthwhile to ensure an Option to Tax is notified to HMRC by the correct method, and that appropriate evidence is retained to prove the tax election has been made.
An Option to Tax covers a specific piece of land, and any buildings that happen to be constructed on it. Consequently, if you notify an Option to Tax on a building it has no automatic effect if you then acquire the building opposite, or even next door.
There are specific rules for situations where neighbouring buildings are ‘knocked together’ but as a general rule, if you own two neighbouring warehouses and rent them out, even to the same occupant, you can have one where you’re charging VAT on rent and one where you’re not – depending on what Option to Tax notifications have been made to HMRC.
Again, bespoke VAT advice will help ensure that any requirements you have are documented and understood so that your position with HMRC is protected.
Like any tax election, the Option to Tax has a number of strings attached and the main one is a twenty-year lifespan. There is a six-month ‘cooling off’ period where an Option to Tax may be revoked (in return for revoking and repaying any beneficial tax recovery that might have been allowed by making the Option in the first place).
Thereafter, the Option to Tax carries the obligation to comply with VAT rules including charging VAT on rent and filing VAT Returns until either the building is sold, or, twenty years have passed. After this time, the Option to Tax can be revoked by making appropriate notification to HMRC.
In practice this can mean that the requirement to charge VAT on rent makes your property more expensive (hence less attractive) to any tenant who cannot recover all the VAT on their expenditure. For example, if a firm of mortgage brokers or a dentist were interested in your property, you might have to reduce the rent to help accommodate the VAT cost for them.
It is important to be aware of this and weigh it as part of any decision to notify an Option to Tax in the first place.
Despite the measures that ensure an Option to Tax cannot be easily avoided, there are some transactions that are never captured by an Option to Tax.
For example, if you build/convert residential property on your land then the subsequent sale or letting of the property will follow the over-riding VAT treatment (likely 0% for first sale of a ‘major’ interest and Exempt otherwise). Land licensed for grazing will generally be taxable at 0%.
Some transactions with registered charities are VAT Exempt. A shop rented to charity for them to trade out of would be governed by an Option to Tax, but, the same shop rented to a charity so they could deliver a drop-in advice service would likely be exempt from VAT.
If you sell your land to a private individual that builds a dwelling for their own occupation, then your sale to them is exempt from VAT. However, if they intend to build a house that they will then sell, rather than live in themselves, there is no automatic VAT Exemption.
If you sell/lease land or buildings to a connected person – essentially any person in your family or company controlled by them – then you need to consider their VAT position. Unless they are going to use the property for a purpose that will allow them at least 80% recovery of their VAT on costs that they incur at the site, your Option to Tax will be ‘disapplied’.
This means that you are not able to charge VAT to the connected person, and in turn it may mean that you are unable to reclaim VAT on your own costs – potentially to the extent that you are required to repay VAT that you have already reclaimed from HMRC.
The rules on ‘disapplication’ of Option to Tax are some of the most complicated in VAT law. Consequently, if you have notified Option to Tax on a property and are considering any new sale or lease you should consider taking bespoke VAT advice on the transaction.
Give our Associate Director, Iain Harris a call if you have any VAT questions. Call him on 0131 364 4191 or email Enable JavaScript to view protected content..
Please note the above commentary is a general guide only, and should not form the basis of specific decision-making.
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