Option to Tax – The importance and effect
Generally, the default position of certain supplies of land and buildings is exempt from VAT, which can often cause problems due to the fact that any input tax related to that exempt supply may well prove to be irrecoverable.
An option to tax is ineffective in respect of residential accommodation, but it may be exercised and effective in respect of certain land or commercial property. The option allows a business to effectively eliminate the default exempt supply and instead make it a standard rated taxable supply. The main effect of such is that VAT is charged on the supply and the associated input tax then becomes recoverable.
A typical worked example:
A landlord acquires a commercial retail unit for £500,000 plus VAT of £100,000 due to the vendor’s option to tax. The only way in which the new landlord can recover this input tax of £100,000 is to ensure they use the building to make taxable supplies with. If they plan to grant leases in the building then they will need to exercise their own option to tax is and by the relevant date. This will allow recovery but the other main impact to be aware of is that subsequent supplies made by the landlord of the retail unit will now also be subject to VAT, meaning VAT must be charged on rental costs to prospective tenants who may or may not be able to recover this VAT depending on their status.
VAT would also be due on the freehold disposal not just the leases granted.
There may be instances where an existing option to tax produces a negative outcome for the parties involved and so, where certain conditions and timing issues are satisfied, the existing option may be disapplied. The effect of this is that the subsequent supply would no longer be subject to VAT at the standard rate and would instead revert back to be exempt from VAT.
Transfer of a Business as a Going Concern (‘TOGC’)
When conditions are met, the sale of a business (including its land/buildings) may qualify to be treated as a TOGC. The ‘supply’ would be outside the scope of VAT, meaning no VAT is charged to the purchaser. In order for opted land and buildings to fall within the TOGC provisions, certain strict conditions must be satisfied, one of which focuses heavily on an option to tax and whether the purchaser of the business has notified this in time.
If, for instance, the purchaser does not notify their option to tax in time (i.e. by the ‘relevant date’), the transfer is at serious risk of not falling within the TOGC provisions meaning VAT would likely have to be charged by the vendor on the sale value associated with the opted property. This potentially creates the following issues:
- The VAT charged by the vendor could be wholly or partly irrecoverable by the purchaser, subject to what the purchaser intends to use the property for;
- If the VAT is recoverable by the purchaser, it still produces a cashflow issue; or
- If VAT is charged, the stamp duty / land transaction tax will be increased as this is levied on the gross purchase price.
The above points, albeit just a brief introduction, touch on an extremely important aspect to consider when selling or buying land and/or buildings, and in our experience the effect of not addressing these points by the relevant time can have a devastating impact. If you or your business is affected by the application of an option to tax, or you would like to discuss the TOGC provisions in further detail, please get in touch with a member of the Centurion