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Commercial Property and VAT: why there IS a reason you might want to opt in

If you’re involved in the purchase of commercial property, this blog post may well be exactly what you’re looking for. If so, we recommend that you stick the kettle on, get yourself comfortable and prepare to be extremely well informed on the subject of opting into VAT. (Not involved in the purchase of commercial property? We recommend that you go and read something more exciting. Really. Go on. Off you pop. Have a look at this instead https://landandlaw.co.uk/proprietary-estoppel-the-offside-rule-of-the-conveyancing-world/)

Okay, now we’ve selected our audience, we will begin on this absolutely thrilling topic. Commercial property, VAT and the option to tax! Don’t get overexcited, it’s far too early in the year for that sort of thing. 

Isn’t property VAT exempt?

Those of you who know your elbow from… other parts of your anatomy may well be pointing out right now that property is exempt from VAT.  Generally speaking, you’re correct. The sale of property and the grant of leases is generally a VAT exempt activity. Property is an ‘exempt supply’. (Catchy, huh?)

Of course, what sort of self-respecting legal system would we have if there weren’t a few loopholes and exceptions?! If you’re purchasing freehold commercial property that is less than three years old, you will pay VAT on the price. https://www.gov.uk/vat-rates

The other major exception here is if your business chooses to waive the VAT exemption on property. You can do this by exercising your right to make use of the so-called ‘option to tax’.

Why in Pete’s name would you want to do that?

We hear you. Mainly we want to legitimately get out of paying tax, not try to pay more of it. Opting into VAT in this sense opens up the possibility of actually saving tax. If a business only deals with VAT exempt supplies and doesn’t collect in any VAT itself, it can’t claim back any of the VAT on its own business purchases. 

This would mean that a property development company who didn’t collect in any VAT from rent or the proceeds of property sales also wouldn’t be able to claim back any of the VAT they’d spent on construction costs or renovation materials. Depending on how much it spent on construction/renovation costs, not being able to claim back 20% of it could be a major blow.

Introduce in 1989, the option to tax scheme gives the option to switch an exempt supply (in this case, commercial property) into a plain old taxable one. Though this would mean they would be eligible to claim back the large chunk of VAT they’d paid to other businesses, it would also mean they’d have to collect in VAT on any of their own income (i.e. rent or sales proceeds). 

What’s the downside?

Well… the main downside is that you have to pay VAT. While the balance of paying VAT in order to recover VAT may work out in some business’ favour, it won’t in others. Each individual business will need to carefully consider their sums (we strongly recommend consulting a very experienced bean counter) in order to work out whether this is likely to be a good choice for them, especially once you’ve factored in the cost of the additional administration required to collect in VAT and submit annual returns.

It’s also vital to consider the impact on customers. Any income being subject to VAT means you’d have to stick an extra 20% on all rents and sale prices.

This might not necessarily be a problem if you were selling to other businesses who are subject to VAT themselves. They could claim back the additional 20% in their own tax returns. If you were hoping to sell or rent to individual the extra 20% could make the deal unaffordable.

This would also be a problem if you were hoping to sell to businesses who fall into exempt categories themselves. They wouldn’t be able to claim back the VAT. This could significantly limit your potential pool of tenants and purchasers moving forwards. 

You’d also need to consider the time commitment. The option to tax isn’t flexible. Once you’ve opted in, you’ll be bound to it for twenty years. In other words, this is a serious long-term commitment that requires significant long-term planning. (Please imagine us using our most serious, grown-up voices here).

What about Stamp Duty Land Tax?

Just to keep the excitement going, we’re going to toss stamp duty land tax into the ring. Because, yes, joy of joys, the option to tax does also have an impact on SDLT.

If you opt to tax, it means any property you are selling will need to be 20% more expensive. This increases the cost of the SDLT. Your buyer will pay SDLT on the whole amount including the VAT inclusive purchase price. 

A few thoughts on the small print of opting to tax

You can only use the option to tax is only available to you if you are VAT registered.

If you do decide to make the commitment, you must supply form VAT1614A to HMRC within thirty days. Once you have opted to tax you have six months to change your mind. Otherwise, you need to wait until twenty years have elapsed.

However, we will note here that the option to tax remains with the developer business not the building itself. A purchase who pays VAT on a commercial building, cannot charge VAT when they come to sell, unless they have opted to tax themselves. 

If you’re considering the option to tax, we’ll happily give you a few pointers. Get in touch and we’ll do what we can to help. We will probably ask you to speak to your accountant though.

The Government Website has lots of useful information in respect of exercising the option to VAT on commercial property : https://www.gov.uk/guidance/opting-to-tax-land-and-buildings-notice-742a

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