The intersection of property and VAT can be a very tricky one. If you regularly advise on commercial property transactions, we think it’s well worth making sure you’re familiar with the regulations around the option to tax.
Isn’t all property VAT exempt?
It’s true that, generally speaking, the sale of property and the granting of leases are VAT exempt activities. Indeed, property falls into the category with the not-particularly-catchy title of ‘exempt supply’.
However, the legal system being what it is, there are a number of loopholes and exceptions to this rule.
Perhaps most importantly, anyone buying freehold commercial property that’s less than three years old will need to pay VAT on it.
The other major exception here comes into play if a business involved in the transaction has chosen to waive the VAT exemption. This is done by exercising their right to make use of the ‘option to tax’.
Why do businesses choose to do this?
It may sound counter-productive, but, for some businesses, waiving the property VAT exemption can actually reduce the amount they pay in tax. This is because businesses who only deal with VAT exempt supplies and therefore don’t collect in any VAT themselves are therefore not eligible to claim back any of the VAT on their own business purchases.
Consider, for example, a property development company. If they chose not to opt in and did not collect any VAT from rent and/or the proceeds of property sales, they also wouldn’t be able to claim back any of the VAT they’d spent on construction costs or renovation materials. Depending on how much they spent on construction/renovation costs each year, not being able to claim back 20% of it could be a major blow.
The option to tax scheme was introduced in 1989 and gives businesses the right to switch an exempt supply (e.g. commercial property) into a plain old taxable one. Opting into the scheme means two things:
- That businesses have to collect in VAT on any of their own income. (e.g. rent, property sales, etc).
- That business are able to claim back the VAT they paid to other businesses.
What does this mean in practice?
Whether or not the option to tax scheme will benefit any single business will depend on a careful balance of financial projections. It certainly does work in the favour of some, but it doesn’t for others. We strongly recommend that you strongly recommend that your clients consult a very experienced accountant in order to work out whether opting in would be a good choice for them. They will also need to factor in the cost of the additional administration that will be required to collect in VAT and submit annual returns.
It’s also vital not to overlook the impact on the business’ customers, and therefore their potential income. When a business opts into VAT, they will need to collect an additional 20% on all rents and sale prices.
This might not necessarily be a problem if the business is selling mainly to other businesses who are subject to VAT themselves, as they could claim back the additional 20% in their own tax returns. However, businesses who are selling or renting to private customers or other VAT exempt businesses could well find that a price hike of 20% makes their property unaffordable. This could significantly limit the potential pool of tenants and purchasers moving forwards.
Businesses also need to consider that opting in to the scheme comes with a time commitment. Once businesses have opted in, they have a six-month window in which they can change their mind. After this, they will be bound to the scheme for twenty years. In other words, this is a very long-term commitment that requires significant long-term planning.
Some final small print
There are some additional pointers about the option to tax that conveyancing professionals should be aware of.
- The option to tax has an impact on stamp duty land tax (SDLT). If a property that is being sold is subject to VAT due to an exemption waiver, the associated SDLT will rise accordingly. The buyer will pay SDLT on the total of the VAT inclusive purchase price.
- The option to tax is only open to businesses who are VAT registered.
- The option to tax remains with the business not the building itself. A purchaser who has paid VAT on a property cannot charge VAT if/when they then come to sell the property, except if they themselves are a business who have opted in.
The Government Website has lots of useful information in respect of exercising the option to VAT on commercial property. If you need any further guidance on this, do feel free to get in touch, and we’ll do what we can to help.