Opting to tax on commercial property

Property remains one of the more complex areas of VAT, where the VAT position can either be standard rated, reduced rated, zero rated or exempt depending on the transaction. The VAT position can also be affected by the use of the property, whether it is commercial or residential and often has significant implications because the values involved can be high.  

This article considers how the option to tax (previously known as an election to waive exemption) for commercial property interacts with all these VAT rules, including some of the common myths around the option to tax.

What is opting to tax?

The default position is that the grant of a freehold, lease, tenancy, or licence to occupy land or buildings is exempt from VAT. The exception to this is where a commercial property is less than three years old, in which case the default position is that the standard rate of VAT applies to a freehold sale. VAT exempt treatment means that no VAT is due on income received but the person making the supply is unable to recover VAT incurred on related expenses. 

Opting to tax land (which includes any buildings or structures permanently affixed to it) means that as a default all the supplies made of an interest in the land or buildings will instead default to be standard rated and VAT is recoverable on costs that are incurred in making those supplies. There are though some specific rules around the scope of an option to tax (in particular, it does not change the VAT treatment of residential property), how an option to tax is to be made and the date that any option is effective from.

Recent changes to the opting to tax process

HMRC announced changes in 2023 that mean they no longer acknowledge an option to tax notified by a taxpayer. As such, evidence which can be collected by a business to prove their decision to make the option and the fact they have notified it to HMRC consists of the automated email reply from HMRC on submission of option to tax notification form VAT1614A and the submitted form itself. 

Putting the address and postcode of the property, and the effective date of the option in the subject line is suggested to evidence the option to tax for that specific property. However, we also suggest adding as much information as possible into the subject line of the email. If an option to tax is submitted to HMRC by post, rather than email, retaining proof of postage is vital to evidence that it has been sent to HMRC.

It is imperative the information on the option to tax form is correct – specifically the address of the land and building and that it is signed by someone who is an authorised signatory. If this information is incorrect, there is a significant risk that the notification to opt to tax is treated by HMRC as being invalid and supplies remain exempt from VAT.

Common misconceptions about an option to tax

Opting to tax is a common occurrence, people all over the UK pay rent on their commercial spaces because the owner or landlord of the land and/or building has made such a decision. Despite the regularity of these situations though, there is still plenty of confusion around the matter. We have looked to “bust” some common myths below.

• When I acquired the property, the seller had charged VAT so that means I have an option to tax over the property.

This is a very common misconception, and we often hear things like ‘I was charged VAT on the purchase so it’s an opted property’. This is not the case, an option to tax is made by the person who has the interest in the property, the option does not move across to a purchaser or tenant automatically.

By way of an example, if a seller opts to tax a property and sells this to the purchaser for £1 million plus £200,000 VAT, the purchaser does not automatically have an option to tax over that property. The purchaser can reclaim the VAT only if it uses the property for a taxable purpose.  If the purchaser intends to lease the property to a tenant, the purchaser will also need to opt to tax its interest in the property.

• I reclaimed the VAT when I purchased the property so it must be opted to tax.

Again, this is also a common misconception. You do not have to make an option to tax in order to reclaim the VAT you are charged on the purchase of the property. The reason for this is that you need to consider the use of the property. As an example, if you are a manufacturing business that makes wholly taxable supplies and you purchase a new factory site, you would be able to recover the VAT incurred on purchasing the site because you are using the factory to make taxable supplies.

• I add VAT to the rent I charge my tenants so I have opted to tax.

Opting to tax is a two-stage process, the first stage is making the decision to opt, and the second stage is to notify HMRC of the decision in writing. Quite often the first stage is completed but not the second stage.

HMRC normally expect a business to notify an option to tax within 30 days of making the decision to opt. Completing the form VAT1614A is the appropriate way of notifying HMRC of the decision to opt to tax. An option to tax has no effect unless it is notified to HMRC within 30 days of when it is exercised.

There are, however, many cases in which VAT has been charged on rent or the sale of a property where an option to tax was never notified to HMRC and that decision has been subsequently accepted. Success on this matter nearly always comes down to whether there was a clear intention with supporting evidence to opt the property in the first place.

• I have held my opted property interest for more than 20 years, does this mean it is automatically revoked?

There are very limited scenarios as to when an option to tax can be revoked, as demonstrated by the main one being where the option to tax has been in place for more than 20 years. However certain conditions must be met in order to do this and as such, an option to tax is not automatically revoked after 20 years.

• I am no longer VAT registered so I no longer have an option to tax on my property.

This misconception has caught many taxpayers out and in a number of different ways. As mentioned, the person, organisation or business with the interest in the property opts to tax, this remains in place until it is either revoked, or the interest in the property is no longer held. This means that once an option to tax has been made, if a business deregisters the option to tax remains in place. As such, if the business has to register for VAT again in the future, there is still a valid option to tax in place.

Another issue arises on deregistration because having opted properties on hand at deregistration results in the business having to account for VAT on the value of the properties under the ‘assets on hand at deregistration’ rules.

It is also worth noting that if a business that has an opted property joins a VAT group, the VAT group is also covered by the option to tax that is in place. As such, changing the VAT status (i.e. registering, deregistering or changing to a VAT group) does not impact the validity of an option to tax or remove an option automatically.

• I’m looking to transfer an opted property as a dividend in specie.

Transferring properties around corporate groups as part of a restructure is a common occurrence but quite often these transactions do not involve the payment of cash as the property can be transferred as a dividend in specie, meaning that the value of the asset is paid instead of cash.

It is worth noting that arrangements such as these are supplies for VAT purposes and even though there is no physical cash being exchanged, VAT is chargeable on the transfer of an opted property as a supply.

To summarise, VAT and property is often very complex and given the values involved in property transactions, it can be expensive to get wrong. If you would like to discuss this further, please get in touch with Rob Janering, or your usual Crowe contact.

This article was first published in Accountancy Daily on 28 February 2024.