Option to Tax

Generally speaking, the supply of land (sale or rental) is exempt from VAT.  Being exempt means that the seller of land cannot charge VAT on that sale.  It also means that the seller cannot recover input VAT incurred on said land.  As the costs relating to land can be significant, so too can the input VAT.  Fortunately, the seller has an option.

Before we go on, first understand that the term ‘land’ includes buildings for the purposes of VAT.  It is also worth noting that ‘zero-rated’ ’ and ‘exempt’ are not the same.  Zero-rated means that the supply is taxable, but VAT is charged at 0%, and as such the sellers can claim back input VAT incurred.

The Option to Tax

The option to tax (‘OTT’) is an election that can be made over non-residential property.  Doing so means that the landlord/vendor will have to charge VAT on the supplies (sale or rental) at the standard rate of 20%.  This might not be good for a few reasons.  Primarily, the customer will now have a higher bill to pay and could subsequently disengage with the business of the seller, particularly if they are unable to recover the input VAT (i.e. because they are making exempt supplies).  For some customers, this will not be a problem as they themselves might be VAT registered and so simply claim back the tax paid from HMRC.   For those that are not VAT registered, this represents a sunk cost.

However, by opting to tax, the landlord/vendor can now reclaim input VAT on expenses.  These might be expenses on acquiring the land itself or expenses incurred on the land after purchase.  This is useful in situations where the seller is renting the property or engaging in other types of business that are exempt from VAT and so would not ordinarily be able to recover VAT costs.

Should you opt to tax?

The OTT is really dependent on one’s circumstances and it will not always be appropriate for every business.  Of course, the ability to reclaim input VAT would help the cash flow of any business, but there are some other factors that might balance out the decision.

First, it is important to know that the OTT is a long-term option and should not be made without due consideration.  The OTT can only be revoked in limited situations which are as follows:

• within a six-month period of the election
• after 20 years of the election; or
• where no interest has been held in the property by the business for six years.

It can be seen then that the OTT generally locks in the business for quite an extensive period of time.  They should therefore be absolutely sure that it is the right choice.

It would be prudent to consider the customer’s position (are they VAT registered), future plans for the property, whether the OTT will spread to undesired buildings and the administration requirements of VAT accounting.

To notify of an option to tax, the VAT1614A form should be completed and sent to HMRC.

The OTT is over the land and buildings owned by the business although relates specifically to that business.  On sale the OTT does not pass to the new owner, and they would (if desirable) need to opt to tax the land/buildings in order to recover any input VAT incurred on the sale.  It should also be noted that, where an OTT is in place, Stamp Duty Land Tax is calculated on the VAT-inclusive value.

Disapply the option to tax (the buyer)

Imagine a buyer is looking to purchase land on which an OTT has been exercised, what can be done?  The buyer can supply the vendor with a VAT1614D.  This is a certificate which disapplies the OTT, thereby making the sale exempt from VAT.  The certificate itself is an official way of notifying the vendor that the land, once acquired, is intended to be used as residential property or that they intend to convert it to such use.

Whilst this sounds great, if this is the first taxable supply the vendor is making there will be a clawback of input VAT reclaimed, including on their acquisition.  If the form is provided to the vendor before exchange of contracts, they must either accept it, withdraw from the transaction, or re-negotiate the sales price.