PPFs and the unexpected traps of opting to tax
One of the most common ways to invest pension funds is to invest in property. Sometimes people own a few house to generate rental income; but I’ve dealt with a number of PPF situations involving commercial property or mixed commercial/residential sites. So today I’m discussing PPFs and the unexpected traps of opting to tax.
Getting your head around the VAT and property rules is difficult for any of us, but when the investments are the main source of income for the rest of your life, the stakes become very personal. So it’s particularly important to get things right from the start.
If you already own some residential properties, you might assume that the same VAT rules apply to commercial property, whether buildings or land. However the rules relating to commercial property are different and quite unique. In particular, the “option to tax” mechanism often catches PPF investors out, especially if they assume that their solicitors or accountants will deal with the VAT side of things.
Whether it’s commercial property or a block of flats, the most important thing is to do your VAT research in advance, or you could be caught out before you’ve made an offer to buy a property. If you don’t register for VAT or issue a certificate to a vendor at the right time, you might end up with either unplanned VAT costs or a lot of hassle to sort out; more often than not, it’s a combination of the two. This can also apply if all you’re doing is a one-off transaction or the occasional purchase to turn a profit when the property market is good.
And if you’re considering a mixed commercial/residential investment, there are two separate sets of rules to consider; each of which are complicated enough in their own right. Putting them together is quite a challenge.
Either way, getting it wrong and having an unexpected 20% VAT bill could have a significant impact on your retirement income. Don’t leave it to your accountant or solicitor; make sure you understand how the VAT rules apply yourself.
The unexpected traps of opting to tax
I don’t know whether the word “trap” is the right one, but over the years, I’ve known many property developers, investors and businesses buying to occupy who have ended up with unplanned VAT bills because they didn’t understand all of the details of the option to tax. Whether you’re buying to develop, occupy or you’re buying to fund your pension, the option to tax can be a very dangerous mechanism.
The option to tax is unique piece of UK VAT legislation, which has existed since 1989. It applies to most non-residential property and most property owners, whether they own a freehold or even just lease a few offices or piece of land, are aware of the main principles.
The option to tax allows the property owner to change the VAT liability of the income from property from exempt to standard rated (i.e. 20%).
The VAT liability of the property also determines whether or not the property owner can claim VAT on costs. If your property income is VAT exempt, then you can’t normally claim VAT on related costs. But if you opt to tax and charge VAT on your property income, you can claim VAT on your costs.
So how does this work in practice? If you’re spending £100k plus £20k VAT on contractors’ services to refurbish or alter a property and you haven’t opted to tax, then you don’t charge VAT on sales or rental income, but you CAN’T claim the £20k on the costs. If you have opted to tax the property, you add 20% VAT to sales or rental income and you CAN claim the £20k VAT. So it makes a substantial difference to the overall cost of the property concerned.
The problem is, that, like all tax rules, the devil’s in the detail. There are several situations where the option to tax is “disapplied”; which means that even if you’ve opted to tax a property, your supplies are still exempt. And this, of course, means that you can’t claim VAT on your costs.
These anti-avoidance rules are primarily designed to prevent exempt businesses from using the option to tax as a way of deferring VAT costs. Over the past few years, I’ve come across a number of situations where potential property deals have fallen through because people didn’t know about these exceptions and didn’t plan for an additional 20% in cost.
The danger signs….
Some of the anti-avoidance rules are specific to property transactions; others are of a more general nature and can apply to other types of business. But the most important triggers are:
- property transactions involving connected parties;
- any transaction involving exempt businesses, especially if they will be the occupants of the property;
- VAT bearing expenditure of £250,000 or above relating to property, including freeholds, leases, licences, but also construction work such as extensions, conversions and even refurbishments.
Either way, it’s really important to research or take advice about any property transaction BEFORE you agree the price, or pay a deposit, and preferably before you’ve even made an offer for the property. Otherwise you may have to find an additional 20% or even more to pay for the property you want.
Marie
December 2015