Back to basics: Introduction to the option to tax

Income from the sale or letting of property is generally exempt from VAT. There are however three exceptions where VAT is chargeable at 20%

1)      The freehold sale of new or partly completed commercial buildings  (‘new’ means a building less than three years old)

2)      Subject to various conditions certain classes of commercial property including hotel accommodation, holiday accommodations, storage buildings etc

3)      The sale or letting of commercial property over which the owner has made a valid option to tax (residential property is not affected by the option to tax)

This article focuses on the basic concepts in relation to making an option to tax. 

So why would someone opt to tax?

The option to tax means the owner has to charge VAT on rental or sale of the property. The main advantages are

1)      The main reason for opting to tax is that VAT on costs e.g. a refurbishment can be recovered whereas without an option the VAT would not be recoverable

2)      Avoiding VAT on a going concern purchase – if a person steps into the shoes of an existing commercial landlord who charges VAT on rental income then as long as certain conditions are met including the incoming purchaser making an option to tax on the property then no VAT is chargeable on the disposal price (this can reduce SDLT costs)

The main disadvantage is that VAT must be charged on the sale or rental of an opted building when the purchaser cannot necessarily recover this VAT.

Is it always necessary to opt to tax?

Situations when an option to tax is not necessary include:

1)      The freehold sale of new commercial property less than three years old

2)      Property owned and used by a person operating a full VAT charging taxable business

3)      Property used for certain property exploiting businesses eg hotels, holiday accommodation, storage etc

In all these examples VAT on costs will be recoverable without an option to tax due to the taxable nature of transactions.

The option to tax is generally relevant to those letting property for rental income. Whilst many tenants can recover VAT added to the rent they are charged some tenants cannot recover VAT due to the exempt nature of their business e.g. financial services and insurance businesses – it goes without saying that these companies would not be keen on letting a building which is subject to an option to tax.

 Buying a property business as a going concern

The Transfer of a Going concern (TOGC) rules are compulsory and if they apply they will take a transaction outside the scope of VAT. This can have useful cashflow advantages as no VAT has to be paid over to the seller by the purchaser.  Special conditions apply to opted investment property that is sold as part of a going concern sale where the property is sold with an existing tenant. In this case one of the key conditions is that the incoming purchaser must also opt to tax and register for VAT for the TOGC rules to apply.

One benefit of the TOGC route for commercial investment sales is that SDLT is added to the VAT free price, whereas on a non TOGC sale which is subject to VAT the SDLT is due on the total sum including any VAT element (even of the VAT is recoverable).

How is an option to tax made? 

An option to tax once made it is notified to HMRC on form VAT1614A. In certain cases a option to tax will require the prior permission of HMRC. In other situations the option to tax once made may be disapplied by a purchaser e.g. the sale of opted commercial property that is intended for conversion into dwellings.  This  can create issues for sellers who would make an exempt sale rather than  a taxable sale with the consequential VAT recovery restrictions.