One of the primary reasons businesses in the UK seek VAT advisory services is to navigate the complexities associated with opting to tax a commercial property. Making the right decision can create significant VAT recovery opportunities, but it can also lead to unintended consequences if not thoroughly planned. Therefore, obtaining expert guidance at the outset is not only prudent but potentially cost-saving.
What Is the Option to Tax?
In general, the sale or lease of commercial property in the UK is exempt from VAT. However, exemption restricts a landlord’s ability to recover input VAT on associated costs, such as renovation, legal fees, or maintenance. The option to tax allows the property owner to elect to charge VAT on the sale or rent of the property, thereby converting an exempt supply into a taxable one.
This option is made by submitting a form (VAT1614A) to HMRC and applies to the property in question, rather than the business itself. Once an option to tax is made, it is usually binding for a period of at least 20 years, except under specific conditions that allow for revocation.
Why Opt to Tax?
1. Input VAT Recovery
The primary benefit of opting to tax is the ability to reclaim input VAT. Without this option, businesses that let or sell commercial properties cannot reclaim VAT on costs related to the exempt supply. This includes VAT on construction, refurbishment, legal services, and agent fees. By opting to tax, these costs become recoverable, significantly reducing the net expense of developing or improving commercial premises.
2. Attracting VAT-Registered Tenants
Most commercial tenants are VAT-registered businesses, meaning they can reclaim VAT on rent or purchase if the property is opted to tax. For these tenants, the added VAT is not a burden. As such, landlords who opt to tax can pass on VAT without affecting the property's attractiveness. This is especially useful in high-value transactions where input VAT on acquisition and development costs can be considerable.
3. Streamlining Complex Portfolios
For businesses with multiple commercial properties, consistent VAT treatment can simplify accounting. Electing to tax all eligible properties ensures standardisation and reduces administrative complexity. When using VAT advisory services, businesses often structure portfolios in such a way that each property’s VAT status aligns with broader strategic or financial objectives.
VAT Implications to Consider
While opting to tax offers benefits, it also introduces new VAT compliance obligations and potential risks. These include:
1. Capital Goods Scheme (CGS)
Properties with a capital cost exceeding £250,000 fall within the Capital Goods Scheme. Under CGS, the recovery of VAT on capital items must be adjusted over a ten-year period. If the property's use changes (e.g., from taxable to exempt), the VAT recovery must be adjusted accordingly. This can lead to significant VAT repayments to HMRC.
2. Transfer of a Going Concern (TOGC)
When selling a commercial property that is opted to tax and let to a tenant, the transaction might qualify as a Transfer of a Going Concern (TOGC). If TOGC rules apply, VAT is not charged on the sale, preserving cash flow for the buyer. However, specific conditions must be met, such as both parties being VAT-registered and the buyer continuing the same business.
Failing to correctly apply TOGC rules can result in HMRC assessments, penalties, or missed VAT recovery. It’s another area where VAT advisory services are crucial in ensuring compliance and minimising exposure.
3. Partial Exemption and Input Tax Attribution
If a business has both taxable and exempt activities, it becomes partially exempt. This status complicates VAT recovery, as only a proportion of input VAT can be reclaimed. The method used to apportion input VAT (e.g., floor area, income ratio) can materially affect recoverable VAT. Where properties are not consistently opted to tax, partial exemption calculations become even more challenging.
Administrative Requirements and Compliance
Making the Option
To exercise the option to tax, the property owner must notify HMRC using form VAT1614A. HMRC may also require evidence that the decision was properly authorised, particularly when the entity is a company or trust. In most cases, HMRC does not acknowledge the option unless explicitly requested. Keeping dated and signed internal documentation is essential in case of future audits.
Record Keeping
Businesses must retain all documents related to the option to tax, including contracts, leases, internal board resolutions, and communication with HMRC. These records must be kept for at least six years. For large property portfolios or long-term leases, this requirement often spans decades.
Proper records are also vital when the property is sold. Buyers, lenders, and their solicitors will usually require evidence that the option to tax was validly made and remains in effect. Lack of documentation can delay or derail transactions.
When Not to Opt to Tax
Despite its advantages, there are scenarios where opting to tax may not be appropriate:
- Selling to or leasing to non-VAT registered businesses or charities: These entities cannot reclaim VAT, so the additional cost may deter them.
- Grant-funded projects: Where grant income is exempt from VAT, opting to tax could reduce eligibility for input VAT recovery.
- Short-term ownership: If a business plans to dispose of the property within a few years, the benefits of VAT recovery may be outweighed by administrative burdens and CGS adjustments.
In such cases, careful cost-benefit analysis—often done in partnership with VAT advisory services—is required to determine the optimal approach.
Revoking an Option to Tax
After 20 years, an option to tax may be revoked. However, in some cases, revocation is possible earlier—within six months of opting, provided no taxable supplies (e.g., rent or sales) have been made. Revocation requires HMRC approval, and the process involves completing form VAT1614J. It’s a nuanced procedure that needs careful consideration, especially if the property is part of a wider development or investment plan.
Case Study: Property Development and Leasing
A UK property developer constructs an office block at a cost of £10 million, including £2 million of VAT. Without opting to tax, the entire project would be treated as exempt, making the VAT non-recoverable. By opting to tax the property, the developer can recover the full £2 million VAT. When the developer leases the space to VAT-registered tenants, rent is subject to VAT, but the tenants can reclaim it, making it a neutral cost.
However, the property falls under the CGS, so if the developer sells the building to an exempt business within 10 years, a portion of the recovered VAT may need to be repaid. This highlights the importance of long-term planning and the involvement of VAT advisory services to assess financial implications across the property’s lifecycle.
Conclusion
The option to tax commercial property is a powerful financial tool in the UK VAT system, offering landlords and investors the ability to recover VAT and align tax treatment with business objectives. However, the decision to opt is not one to be taken lightly. It carries long-term commitments, compliance obligations, and potential pitfalls that require careful navigation.
Professional advice is indispensable. VAT advisory services help businesses assess whether opting to tax aligns with their current and future property strategy, guides them through compliance procedures, and supports accurate VAT recovery under complex rules such as CGS and TOGC.
For UK businesses engaged in commercial property transactions, the option to tax is not just a tax decision—it’s a strategic one that influences cash flow, marketability, and operational flexibility. With the right planning, it can be a key driver of financial efficiency and success.