One of the most regular VAT questions is whether you can recover VAT on the costs of repairing or converting a commercial property. A lot of businesses have spare office space, or a disused warehouse or factory and want to generate some rental income to help cover costs.
And as just about every business in the UK has property of some sort or another, queries about VAT and property are probably the most common from all commercial sectors.
As I’ve said again and again, the VAT legislation concerning property is very complex and there are several factors to consider before you can establish whether or not VAT on such costs can be claimed. So I thought it would be helpful to explain the main rules as a starting point on the subject.
The basic rule and the option to tax
Normally, you can only recover VAT if you are registered for VAT and make “taxable supplies”, in which case you can claim VAT on costs incurred in making those supplies. Leasing a commercial building is normally exempt from VAT so in principle, it isn’t possible to claim VAT paid on costs, which might include conversion work or maintenance.
However there is a facility within the VAT law which allows property owners to “opt” to tax certain buildings. This is known as the “option to tax”. It allows the property owner to choose to change the liability of supplies of the building concerned so that their supplies will be taxable rather than exempt. Once the option to tax has been made, the property owner charges VAT on subsequent rental income or sales proceeds and can also claim back VAT on costs relating to the property concerned.
The rules on this are quite lengthy and can be found VAT Notice 742a: “Opting to tax land and buildings” on the HMRC website here: http://tinyurl.com/ckzyhk [Open in new window]. It is a long notice but is a good explanation of the rules and an essential reference notice on this subject. I would recommend that you sit down and read this when you have an hour or so to spare so that you have time to read it properly.
Deciding whether to opt to tax
So the benefit of opting to tax is that you can claim back the VAT on costs and therefore you might assume that it makes sense to opt to tax every commercial property in your portfolio. But in practice this might not be the best commercial decision.
If the prospective tenant is not registered for VAT or is partly exempt, adding VAT to the rent could simply increase their costs by 15% or 17.5%, depending on the rate of VAT in force at the time. If they can rent a property for a similar rent without VAT, then your offering might be less appealing. Of course it isn’t that simple as a property owner who hasn’t opted a property would price his rental income to take account of his irrecoverable VAT costs.
However the proportion of commercial properties that are “opted” is every increasing as the option to tax has existed since 1989. Most exempt businesses are used to paying VAT on commercial property as successive owners have opted during the past 20 years.
Normally once you’ve made an option to tax, you only have 2 opportunities to “revoke” the option – first, within a six month “cooling off” period and second, after 20 years. So it is important to make the decision carefully as you could be stuck with it for a very long time! Also stamp duty land tax (“SDLT”) is payable on the VAT inclusive price of a lease, so the cost of the SDLT will increase by an equivalent proportion if the property is opted.
Following those rules
If you decide to opt to tax the building, please be very careful about following the rules set out in Notice 742a. If you’re not currently registered for VAT because your existing taxable supplies are below the VAT registration limit and you are considering opting a building, the most important point is that if you make the option, you will have to register and charge VAT on all of your taxable income. Plus you will have the hassle of preparing and submitting VAT returns every few months. In these circumstances, it may not be worth the hassle just to claim back some VAT on the property costs.
If you do decide to opt to tax, there are many potential factors to consider. For example if you’ve previously used the property to make exempt supplies (eg a previous lease for exempt rental income) then you might have to ask permission from HMRC to make the option to tax.
There are also very specific practical requirements about how and when to notify, so you have to be very careful to submit the necessary notifications by the required deadlines. And there are complex anti-avoidance rules that can apply if the cost of certain building work, such as conversion of a property, is £250,000 or more net of VAT and the proposed tenant will be exempt or partly exempt.
Flashing red traffic light……
If I were to rate the option to tax by a traffic light system, it would most definitely be a very persistent flashing red. Unless you are very familiar with the VAT rules, then I would recommend that you take advice on this issue. Your accountant should be familiar with the main issues involved as a starting point or take specialist VAT advice especially if the amounts of money involved are particularly large.