It seems like a lifetime ago since the option to tax was introduced into UK law and I think it’s a good time to remind ourselves about revoking the option to tax under the 20 year rule.

But let’s go back to basics and the purpose of “opting to tax”.  At the time, it seemed like an odd thing – for the first time in UK law, the property owner could CHANGE the VAT liability of the sales or rental income from exempt to taxable.  Nowadays that means adding 20% to the rent or sales price.

Opting to tax

It all started in 1989 when the UK government introduced VAT on commercial construction and sales of “new” commercial properties (i.e. up to 3 years after completion).  Before this, the VAT and property rules were basically the same for all types of property, so construction of a new office or retail mall or factory was zero-rated, just like new dwellings and other residential buildings.  Unfortunately this didn’t fulfill EC law so the government was required to change the rules.  The zero-rating and exemptions for residential property was only allowed because these properties were for the personal use of private individuals.

Of course, opting to tax a property means that the owner can claim VAT on related costs and business clients can claim VAT charged on the rent on their VAT returns.  But the option to tax rules could be complicated – for example if you opted to tax a shop in a shopping centre, then in principle your option also applies to any other shops in that mall.

But the main casualty of this new rule were those exempt businesses – the banks, insurance companies, building societies, private hospitals etc – who can’t claim VAT.  And it wasn’t just a case of the option to tax – the issue was made even more complex by the introduction of the Capital Goods Scheme whereby property owners have to adjust VAT recovery over a 10 year period.  Other complex situations and avoidance schemes made the whole subject very complicated.

20 years is a long time in the world of property….

One of the downsides of opting to tax was, of course, that it added 20% to the selling price. So it’s not surprising that property owners were reluctant to make the option , especially in the early days when there were plenty of “exempt” properties on the market.  Plus adding VAT to the selling price means that the stamp duty land tax increased as a result.

But the property market has changed a lot since 1989 and nowadays, you’re just as likely to find opted commercial properties for sale or rent as exempt properties.  It’s no longer such a significant barrier to letting or selling as it was originally.

Most of the options to tax made in the early 1990s were made to enable property owners to claim VAT on new buildings or construction costs.  In either case, the Capital Goods Scheme meant that property owners had to adjust their VAT recovery over a period of 10 years.   For example, if a purchaser claimed VAT on the purchase on the basis that they planned to sell the freehold as a “new” commercial property, then leased the property exempt from VAT over the following years without opting to tax, they’d have to repay the VAT claimed from HMRC 10% for each of the 10 year periods.  Or if they rented VAT exempt without opting to tax then sold the property 6 years later, they could opt to tax and claim up to 40% of the VAT on the initial purchase.

The important thing about the CGS is that the 10 year adjustment period for those initial opters is now long gone, which means that property owners don’t have to make any further adjustments under the scheme.  This means that they could now revoke the option to tax without any CGS liability so that their future income from sales or leasing is exempt.  And as I’ve explained below, this can be a very useful option, especially if you you’ve ended up with different use of the property – eg a number of different leases or licences for different parts of the property that are coming to an end – and you want to have a VAT free property to put on the market.  Purchasers can also benefit from the stamp duty land tax saving because stamp duty is normally paid on the VAT inclusive selling price.

Of course, revoking an option to tax means that the owner/vendor won’t, in principle, be able to claim VAT on related costs because their income will be VAT exempt.  So if you’re considering revoking an option, you need to check out how much irrecoverable VAT you may incur.  But even if you do lose a little VAT on costs, having a VAT free property could be a much more valuable commodity in the property market.

VAT 1614J

If you opted to tax more than 20 years ago, you can request HMRC’s permission to revoke the option under the 20 year rule using VAT Form 1614J, as explained in VAT Notice 742a: Opting to tax land and buildings, section 8.3 http://tinyurl.com/k5azk4p.  

For the most part it’s a relatively straightforward process, though there are some anti-avoidance provisions that apply to certain exempt or partly exempt businesses.

Revoking the option to get a “VAT exempt property”

What I’m finding interesting is how, over the years, certain property arrangements have become so complicated and the VAT issues so messy for the owners that revoking the option to tax can provide a very simple mechanism for “wiping the slate clean” and simplifying the VAT issues.

I came across a very good example of this recently.  A private company owned by a group of individual houseowners had purchased a large plot of land adjacent to their estate with the longer term intention of selling the property to a developer at a profit.  The company purchased the land in 1976 and opted to tax the site in 1996 so that it could claim VAT on related costs, which included solicitors fees, agents fees and the costs of repair and maintenance of the site.

In the intervening years, parts of the site were put to use to raise some income to help fund the ongoing costs.  This included a grazing lease, car parking for a local golf club and letting part of the site to the local rugby club.  With these existing activities, the company could have sold at least part of the the site VAT free as the sale of a business as a going concern.  However each of these arrangements were on individual timescales, some with less formal arrangements, and probably not cost-effective to incur the cost of transferring landlord/tenant arrangements to a new owner.

This year, the company reached a tentative agreement to sell a significant part of the site to a developer.  The land, now valued at several £million, would be used to create a new housing development for freehold sales.  The developer would be able to claim VAT on the cost of the land, but had not factored the stamp duty land cost into his costs, which could add an additional six figure sum.

This is when revoking the option to tax becomes very useful.  By revoking the option to tax under the 20 year rule, the company has a “VAT free” site, which adds to its value as a potential property development site.

The “option to tax” is, of course, a VAT issue and for many property owners, it can cause hassle and increase costs and take a lot of time to get right. But if you’ve owned property for more than 20 years AND you’re not caught by the anti-avoidance provisions, it can provide a very good “get out of jail” card.  Definitely worth considering if you’re planning to sell property or as part of regular property portfolio review.

Marie

August, 2016