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The VAT rules surrounding land and property are complex and can often be confusing, even to experienced professionals. This brief summary aims to explain the terminology, dispel some common misconceptions and briefly describe the VAT implications using a simple example.

A basic principle of VAT is that, as a VAT registered business, you may only recover VAT where you make or intend to make a taxable supply. Simply put, if you make standard rated, reduced rated or zero-rated supplies as a VAT registered business, you will be able to recover the input VAT suffered on your purchases. 

Land and property (including buildings and civil engineering works) have their own specific VAT rules and with the exception of some newly constructed property, are generally exempt from VAT. Being exempt means that output VAT is not chargeable on supply, but equally input VAT suffered on purchases is not recoverable either.

What is an ‘option to tax’?

An ‘option to tax’ is the common terminology used when the owner/leaseholder of land or property elects with HM Revenue and Customs for that land or property to be treated as VATable, thereby making any subsequent sales, lease or rental of the land or property a standard rated supply. It is one of the rare occasions where a VAT registered business can alter the VAT treatment that applies to a transaction. 

Why would I consider opting to tax?

The option to tax election could be beneficial when the two following situations occur together:

  • A substantial amount of input VAT can be reclaimed on large renovation costs of a non-residential property, and 
  • The property owner is planning to rent it to another business that is VAT registered, who makes taxable supplies and therefore is able to claim any VAT charged on the rent.

For example, a landlord renting an industrial unit would normally be an exempt business activity for VAT purposes. As a result, the landlord would not charge VAT on the rent, but would not be able to claim any VAT on property costs either. If the landlord were to register for VAT and make an option to tax election, they would be able to recover VAT on costs associated with the property business. The landlord would also have to charge rent with VAT applied at the standard rate. However, providing the tenant is also VAT registered and making taxable supplies, they will be able to recover the VAT resulting in a neutral effect for the tenant.

Like the example above, there are certainly situations where this special area of VAT legislation is beneficial to property owners, but it is not a decision to be taken lightly. Once an owner has made an election and a six-month cooling off period has passed, the owner’s option to tax becomes irrevocable for 20 years!

Dispelling myths

One of the most common misconceptions is that the option to tax remains with the building when it is sold, passing to the new owner. This is not the case. The option to tax covers a person’s interest (or business entity such partnership of limited company) in a property and is extinguished when their ownership, right over or licence to occupy passes to a new person.

If you would like more information and specific examples regarding VAT on land transactions, please do not hesitate to contact me or your local Thomas Westcott office.

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