The option to tax and its effects has always been a very complicated subject. As property is usually valuable, an error or a misunderstanding can be costly.
How the option to tax works is specified in VAT Act 1994, Schedule 10 Part 1.
What is the point of the option?
To allow a taxpayer to reclaim input tax incurred on the property which would otherwise relate to an exempt use of the property and would not normally be recoverable. Some of the main points to remember are covered below.
Basics on opting
Residence – you cannot opt a property outside the UK
The decision to opt must be notified in writing to HMRC within 30 days of the taxpayer making their initial decision to opt. Note the use of the words ‘decision to opt’ which is different to, say, the date of purchase.
The process of making an ordinary option to tax is two stage. The first stage is making the decision to opt, the second is notifying that decision in writing to HMRC to give it legal effect. Both stages are necessary for there to be a legally valid option to tax. Note that the law does not prescribe how the decision to opt (the first stage) should be made.
Get the option date right – you can opt to tax from any date within 30 days of making your decision or any date in the future.
Belated and retrospective applications
There is a difference between the two so it’s important to get the details correct. Timing is everything and the clock can’t be turned back. Belated notification is when a decision was made but the notification was not.
The law does not allow a person to make a retrospective option to tax (in other words, a person cannot decide today to opt with effect from an earlier date) so getting the timing wrong could jeopardise – for instance – a transfer of a going concern which can’t be applied retrospectively as a valid option to tax was not in place on or before the relevant date.
Recovering input tax
Your entitlement to recover any input tax you incur will depend on the liability of the supplies you make or intend to make. This can be affected by opting to tax, but you cannot assume that an option to tax will allow full input tax recovery. You must still consider what supplies you will make and their liability:
If the following is made
Then you will normally be
Taxable supplies of the land and buildings
Able to recover any input tax relating to those supplies
Wholly exempt supplies of the land or buildings
Unable to recover any input tax relating to the taxable supplies
Supplies that are both taxable and exempt, for example an option to tax on a building that is to be used both commercially and residentially
Able to recover only the input tax relating to taxable supplies – see VAT notice 706 (partial exemption)
Option to tax – how does it affect transfer of a business as a going concern?
This is a vital area as many businesses are sold in this manner. Where they involve property the timing/notification of the option is crucial and HMRC have plenty of anti-avoidance legislation they can use if relevant.
TOGC allows the sale to be treated as neither a supply of goods nor a supply of services. Note that the vendor is ultimately responsible for applying the correct VAT treatment. Where property is concerned they must be satisfied that:
the purchaser’s option to tax is in place by the relevant date
have opted to tax the land or buildings being transferred and the option is not disapplied in relation to the transfer
are transferring the freehold of a ‘new’ building and the supply, but for the TOGC, would be subject to the standard rate of VAT.
The additional conditions are that the purchaser must have:
opted to tax or made a real estate election (these must have been both notified to HMRC and effective on or before the relevant date - paragraph 14.8 explains how to notify a real estate election)
notified you that their option to tax will not be disapplied under the anti-avoidance provision set out in VATA 1994, Schedule 10, paragraph 12 in respect of supplies they intend to make of the land or building (see section 13).
So what does notification mean? By ‘notified to HMRC’ it means that the purchaser has properly addressed, pre-paid and posted (or faxed) the appropriate form or letter. The declaration that the option will not be disapplied must also be made by the relevant date.
As evidence of the importance of getting the details right, in a recent webinar HMRC provided six pages of links to the legislation, guides and their own internal manuals. These are reproduced here