A tax choice which can go wrong

Richard Wild of PKF explains the pitfalls concerning “opting in” to VAT on property

Richard Wild of PKF explains the pitfalls concerning “opting in” to VAT on property

SUPPLIES of land and property are normally exempt from VAT but, as always, there are a number of exceptions.

Where exemption applies no VAT is charged on income from sales or rents, but no VAT is recoverable on construction, acquisition, or refurbishment costs.

One important exception arises from an “option to tax”, which can convert an otherwise exempt supply of commercial property into one which is VATable at the standard rate. However, the decision to opt formally to tax (charge VAT on) a property needs careful consideration.

Opting to tax may enable VAT on your costs to be reclaimed when they would otherwise be irrecoverable. For example, if a property was exempt from VAT when acquired, but requires refurbishment prior to being let to tenants, the VAT on the refurbishment costs will not be reclaimable unless an option to tax is exercised and VAT charged on the subsequent rentals.

Clearly, it is important to think of the VAT position of your tenant, or potential tenant, before you opt to tax, as knock-on costs of adding VAT to the rent you charge may prove more expensive in the long run than suffering the VAT on the refurbishment costs. It is the long term impacts that are most important here as, apart from a short initial cooling off period, an option to tax lasts a minimum of 20 years.

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Keeping evidence of an option to tax is extremely important and was highlighted in a recent Tax Tribunal case. A company had acquired a property, subject to VAT, which it let to an associated company; nothing unusual there. Following discussion with HMRC, the company recovered VAT on the acquisition cost, though it did not charge any VAT on the rentals.

When HMRC subsequently discovered that the company was not using the premises for its own taxable business purposes, but for the purpose of letting to its associate, it raised an assessment for �80,675 to recover the VAT the company had reclaimed.

The company argued that it had opted to tax the premises, but had failed to notify HMRC and charge VAT on the rent. However, it became apparent in the Tribunal that the company's officers could not have opted to tax the property as they were completely unaware of the option to tax system. As a result, the company was faced with an unexpected, and entirely avoidable, VAT bill.

As the option to tax was first introduced on August 1, 1989, we are rapidly approaching its 20 year anniversary. Therefore, property businesses who chose to opt to tax their properties in 1989 will soon have an opportunity to “opt out”, i.e. change back to making exempt supplies of the property.

Again, this needs careful thought as it may remove the entitlement to VAT recovery on costs. However, if your existing tenant cannot recover all the VAT it incurs, or you are marketing a property for sale or rent, removing 15% VAT from the price may make your premises more attractive.

Even in the current climate, property may remain a business' highest value asset, and it is vitally important to ensure that its VAT status is actively managed to your advantage.