VAT and the option to tax: Part 3

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Neil Warren highlights common errors and problems that can go wrong in practice with the option to tax.

Disapplying the option

It is always better to not pay VAT in the first place (legally, of course) than to pay it to a supplier and then claim it as input tax. An example of this situation is when a person is buying a non-residential property that they intend to convert into dwellings or use as a dwelling or dwellings.

Example 1

Jane is a property developer and registered for VAT. She has agreed to purchase an office block from Steve for £500,000 + VAT, which she will convert into ten flats to either rent out or sell. In this situation, Jane should issue form VAT1614D (certificate to disapply the option to tax buildings for conversion into dwellings) to Steve before exchange of contracts to confirm her intentions. The sale of the property by Steve will then be exempt from VAT.

Steve can’t refuse to accept the form VAT1614D – see Notice 742A, para 3.4.3. The form is not sent to HMRC. Jane doesn’t need to have planning permission in place at the time of completing form VAT1614D, it is all about her intentions.

Residential property

If a property is part commercial and part residential, the option to tax election only applies to the commercial part.

Where a property owner earns rental income from say a ground floor shop and first floor flat, they must never charge VAT on the rent from the flat, unless the flat is let as holiday lettings, which are standard rated by statute. The outcome is that the owner’s business will be partially exempt, with an input tax restriction on costs relevant to the flat, and a partial restriction on any costs that relate to both parts of the property, such as a roof repair.

Deregistration trap

If a business deregisters for VAT purposes, then it is liable to account for output tax on any standard rated stock and assets it owns on the date it deregisters, but only if it claimed input tax on the initial purchase price. However, if the total VAT payable under these rules is less than £1,000 (ie the net value of the stock and assets subject to VAT is less than £5,000), then no VAT is due and it can be left off the final VAT return submitted by the business.

An opted property would come within these rules if VAT was charged when it was purchased and claimed by the business as input tax. Output tax is payable based on the market value of the property on the date of deregistration and declared in Box 1 of the final VAT return submitted by the business.

Twist to the tale

What is the position if the deregistering business made an option to tax election on the property it owns, but no VAT was charged and claimed when it was purchased? The good news is that the output tax declaration explained above is not needed, but the business owner is not free of their VAT obligations.

If the business owner sells the property in the future, after they have deregistered, this will be a taxable sale because of their option to tax election. They must re-register for VAT and account for output tax on the sale if the selling price, and any other taxable income, exceeds the registration threshold of £85,000. This is because they will be making taxable sales exceeding £85,000 in the next 30 days, so must register for VAT at the beginning of the 30-day period.

The key principle here is that although a business has deregistered from VAT, any past option to tax elections made by the business owner are still valid. Those elections are not automatically cancelled alongside the VAT deregistration.

Connected party sales and anti-avoidance

My final challenge is best highlighted in the following example.

Example 2

Jack and Jill trade in a partnership as a children’s nursery and are not VAT registered because all of their income is exempt from VAT. They want to buy the freehold of a building where the seller will charge 20% VAT on the selling price of £500,000. The building will be wholly used for the nursery business and they have asked their accountant if it will be possible to buy the property in a connected legal entity (eg a limited company where Jack and Jill are shareholders). This company would then make an option to tax election on the building and register for VAT, so that input tax of £100,000 can be claimed on the property purchase. The new company will then charge a commercial rent to the partnership of say, £20,000 a year plus VAT.

In this situation, the strategy is blocked by anti-avoidance legislation (see VAT Notice 742A, section 13) and any option to tax election made by the legal entity buying the property would be disapplied because of the following factors:

  • The two legal entities are connected to each other as defined by CTA 2010, s 1122;
  • The trading business is making exempt supplies which exceed 80% of its total supplies
  • The property is within the capital goods scheme regulations, ie it cost more than £250,000 excluding VAT.

About Neil Warren

Neil Warren

Neil Warren is an independent VAT consultant and author who worked for Customs and Excise for 14 years until 1997.

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