VAT on commercial property is a complex area and often misunderstood. The intricacy of the Opting to Tax regulations is a case in point.
These regulations were introduced on August 1, 1989, and include a critical landmark being the 20th anniversary of the date that any option to tax was taken, after which it is possible to revoke the option.
It seems almost impossible, but is true, that the 20-year period will now have expired for properties owned back in the late eighties and the incidence of expiry of the 20-year period will become more frequent in the next few years. As a result the number of opportunities to consider whether it might be beneficial to revoke the option with HMRC will increase.
The reason why many businesses opted to tax was in order to create the ability to recover the input VAT which often arose on the purchase of a building or possibly on substantial improvement or repair costs. Only by charging VAT on the rental income was it possible to recover the input tax on these costs.
As a result of the option to tax, the sale of the property will be subject to VAT at the standard rate and Stamp Duty Land Tax (SDLT) will be calculated, not on the sale price, but the gross price including VAT, which is a substantial additional cost to the purchaser.
The need to charge VAT on the property sale with the resulting increase in SDLT will be avoided if it is possible to come within the criteria of a transfer of a going concern (TOGC). In essence if the buyer is acquiring a property rental business rather than simply a commercial building and both parties qualify for a TOGC, the transaction will be outside the scope of VAT. It should be remembered that under these circumstances a new 20-year period starts for the new owner.
If it is not possible to comply with the conditions required for a TOGC the purchaser will be paying up to an additional 26% to acquire the building.
This is where the 20-year limit may be of assistance.
If the intended purchaser’s activity is mainly exempt from VAT, such as the medical profession, insurance providers, financial institutions, undertakers, betting shops, casinos, educational or charitable establishments, the seller should consider revoking the existing option to tax. That would result in the future income from the property being treated as an exempt, rather than standard rated supply including the proceeds from a sale of the property. The VAT charges would be avoided as would the additional SDLT.
Before revoking the option to tax it is important to consider any substantial capital expenditure on the building incurred within the previous 10 years which could be subject to adjustment under the capital goods scheme.
In the case of existing tenants who are unable to recover the VAT because of their own exempt supplies, they might explore whether their landlord would be prepared to revoke the option to tax. This might be a good strategy to employ during a rent negotiation.
There are times when it is not appropriate for a purchaser to opt to tax a building that they are acquiring. Many people assume that because the previous owner had opted to tax a building, the buyer should also opt to tax. Certainly if the option to tax is not made by the purchaser there will be an increase in the SDLT since the criteria for a TOGC will not be met and VAT will be due on the transaction. Of course, this may be an acceptable cost in view of the fact that otherwise the option to tax will last 20 years and might have a detrimental impact on a subsequent sale should the buyer have a VAT exempt business.
Often the cashflow impact of paying 20% VAT upon completion is a decisive factor but it may be possible to agree with the vendor for this element to be deferred until the date when the buyer can recover this input tax in the normal course of submitting their VAT return.
Businesses that do not make exempt supplies are able to recover all their input tax regardless of whether or not they have opted to tax the building from which they trade. By not opting to tax the property they hold open the possibility that they could sell the property to anyone including those making exempt supplies without charging VAT on the sale proceeds.
The complexity of the rules surrounding the VAT treatment of commercial property transactions is such that it would be wise to seek experienced professional advice in respect of the tax consequences of any proposed action before the event.